Low cost carrier competition and route entry in an emerging but regulated aviation market – The case of China

Although China lags behind other liberalized aviation markets in low cost carrier (LCC) development, its largest LCC, Spring Airlines, has achieved rapid growth in traffic volume and revenue, as well as consistent profitability, since its inauguration in 2005. Our empirical study on the Chinese domestic market suggests that Spring adopts a “cream skimming” strategy to enter high-priced routes, allowing the carrier to achieve both a very high load factor and considerable profitability. Spring’s capacity and market share on individual routes are constrained to low levels, likely due to government regulation and/or a “puppy dog” strategy adopted by the carrier. As a result, Spring is able to achieve fast growth without triggering price wars. To incumbent full service carriers, high speed rail (HSR) services impose much more significant competitive pressure than low cost carriers. Similar to LCCs in developed markets, Spring prefers to serve markets with high traffic volumes out of its operational base in Shanghai. Overall, Spring’s entry decision is not significantly affected by competition, either from full service airlines or HSR services. Our investigation suggests that LCCs have potential to introduce more competition but are yet to be a “game changer” in China. Further deregulation of the domestic market is needed.     

On the relationship between airport pricing models

Airport pricing papers can be divided into two approaches. In the traditional approach the demand for airport services depends on airport charges and on congestion costs of both passengers and airlines; the airline market is not formally modeled. In the vertical-structure approach instead, airports provide an input for an airline oligopoly and it is the equilibrium of this downstream market which determines the airports’ demand. We prove, analytically, that the traditional approach to airport pricing is valid if air carriers have no market power, i.e. airlines are atomistic or they behave as price takers (perfect competition) and have constant marginal operational costs. When carriers have market power, this approach may result in a surplus measure that falls short of giving a true measure of social surplus. Furthermore, its use prescribes a traffic level that is, for given capacity, smaller than the socially optimal level. When carriers have market power and consequently both airports and airlines behave strategically, a vertical-structure approach appears a more reasonable approach to airport pricing issues.     

The impact of strategic management and fleet planning on airline efficiency - A random effects Tobit model based on DEA efficiency scores

As a result of the liberalisation of airline markets; the strong growth of low cost carriers; the high volatility in fuel prices; and the recent global financial crisis, the cost pressure that airlines face is very substantial. In order to survive in these very competitive environments, information on what factors impact on costs and efficiency of airlines is crucial in guiding strategic change. To evaluate key determinants of 58 passenger airlines’ efficiency, this paper applies a two-stage Data Envelopment Analysis (DEA) approach, with partially bootstrapped random effects Tobit regressions in the second stage. Our results suggest that the effects of route optimisation, in the sense of average stage length of the fleet, are limited to airline technical efficiency. We show that airline size and key fleet mix characteristics, such as aircraft size and number of different aircraft families in the fleet, are more relevant to successful cost management of airlines since they have significant impacts on all three types of airline efficiency: technical, allocative and, ultimately, cost efficiency. Our results also show that despite the fuel saving benefits of younger aircraft, the age of an airline’s fleet has no significant impact on its technical efficiency, but does have a positive impact on its allocative and cost efficiency.     

One price for all? Price discrimination and market captivity: Evidence from the Italian city-pair markets

This paper tests whether, and to what extent, airlines exploit market captivity by using price discrimination strategies. The Italian passenger market is particularly fit for this purpose, given the high differentials in the degree of the inter-modal competition amongst domestic connections. Results show that, ceteris paribus, airlines adopt a different pricing behaviour depending on the degree of inter-modal market captivity. First, in highly concentrated markets with respect to air competitors, airlines price higher when the inter-modal competition is limited. This proves that inter-modal market captivity strengthens the effect of market power. Second, the inter-temporal price discrimination leads to a J-shaped distribution of fares over time, which is more pronounced when the inter-modal competition is effective. This suggests that airlines need to adopt a pricing technique that allows for a greater market segmentation in order to compete successfully with high-speed rail transport and to extract a larger part of passengers’ surplus. These results are relevant in terms of transport-investment implications and competition policy. The indirect benefits that investments in rail infrastructure would yield through downward pressures on competing airline fares should be embedded in any cost-benefit analysis of high-speed networks investments and in any policy evaluation of measures that aim to reduce the territorial gaps in infrastructure endowment and accessibility.     

Revenue sharing with multiple airlines and airports

This paper investigates the effects of concession revenue sharing between an airport and its airlines. It is found that the degree of revenue sharing will be affected by how airlines’ services are related to each other (complements, independent, or substitutes). In particular, when carriers provide strongly substitutable services to each other, the airport has incentive to charge airlines, rather than to pay airlines, a share of concession revenue. In these situations, while revenue sharing improves profit, it reduces social welfare. It is further found that airport competition results in a higher degree of revenue sharing than would be had in the case of single airports. The airport–airline chains may nevertheless derive lower profits through the revenue-sharing rivalry, and the situation is similar to a Prisoners’ Dilemma. As the chains move further away from their joint profit maximum, welfare rises beyond the level achievable by single airports. The (equilibrium) revenue-sharing proportion at an airport is also shown to decrease in the number of its carriers, and to increase in the number of carriers at competing airports. Finally, the effects of a ‘pure’ sharing contract are compared to those of the two-part sharing contract. It is found that whether an airport is subject to competition is critical to the welfare consequences of alternative revenue sharing arrangements.     

Airline network choice and market coverage under high-speed rail competition

While the existing literature has focused on the short-term impacts, this paper investigates the long-term impacts of high-speed rail (HSR) competition on airlines. An analytical model is developed to study how an airline may change its network and market coverage when facing HSR competition on trunk routes. We show that prior to HSR competition, an airline is more likely to adopt a fully-connected network and cover fewer fringe markets if the trunk market is large. Under HSR competition, the airline will, for a given network structure, have a greater incentive to cover more fringe (regional or foreign) markets if the trunk market is large, or the airline network is close to hub-and-spoke. Further, the airline will, for any given market coverage, move towards a hub-and-spoke network when the trunk market is large, or the number of fringe markets covered by the airline network is large. Both effects are more prominent when the decreasing rate of airline density economies is large. We further show that HSR competition can induce the airline to adopt network structure and market coverage that are closer to the socially optimal ones, thereby suggesting a new source of welfare gain from HSR based on its long-term impacts on airlines. Implications for operators, policy makers and specific countries (such as China) are also discussed.     

Airport and airlines competition: Incentives for vertical collusion

This paper develops a model of airport and airline competition in a three-stage game. We analyse incentives for vertical collusion between one airport and one airline that compete with another airport and another airline, by means of static and dynamic games. We find that incentives for collusion exist when airports and airlines have different market sizes and, under certain conditions, also when secondary airports and low cost airlines compete with main airports and full service airlines.     

Differences in air passengers’ buying behaviour: findings from Korean and Australian international passengers

Abstract

This paper investigates how air passengers’ expectations, ticket price, airline service quality, value, passenger satisfaction and airline image determine their buying behaviour. To test the conceptual frameworks, path analysis was applied to data collected from Korean and Australian international passengers to examine differences between these two groups. Further analyses were undertaken on different passenger segments between national and foreign airline passengers. The results of the path analysis reveal that air passengers’ buying behaviour differs significantly between Korean and Australian international passengers. Results also reveal that the determinants of air passengers’ buying behaviour differ by airlines.     

Strategic considerations behind the network–regional airline tie ups – A theoretical and empirical study

The paper examines the strategic vertical relationship between network and regional airlines. We develop a model to illustrate how network airlines can use the contractual relationship with regional airlines as an efficient tool to simultaneously drive out inefficient network airlines and also accommodate other cost efficient network airlines in any specific market. The model is tested on U.S. data using simultaneous and sequential choice models. We find that market size, cost differences between network airlines, as well as cost differences between network and regional airlines, are the chief determinants of the network airlines’ decisions on whether or not to serve a market with their own fleet, as well as how many regional airlines to contract with.     

Price effects of airlines frequent flyer programs: The case of the dominant firm in Chile

Frequent flyer programs create a switching cost for the consumer and allow firms to obtain rents, for example, by exploiting the principal agent problem existing between the employee who travel and purchases the ticket and the employer paying for that ticket. In Chile LAN is the dominant airline in domestic markets and the only one that has a frequent flyer program (FFP); it faces some competition from two small carriers. Using a unique dataset for Chile, collected by ourselves from airlines websites in 2011 and 2012, we estimate the impact of the dominant airline FFP. For this purpose, we compare for each route the fares between airlines and between weekday trips (that accumulate full miles and are mainly for business purposes) and weekend trips (that accumulate less than full miles and are mainly for leisure purposes). The results show that the differential premium LAN is able to charge for weekday trips due to the FFP is around 35%. Three particularities of the Chilean market help the econometric identification: there is only one hub for all airlines (the capital city of Santiago), there is no business class in domestic flights, and none of the airlines is a low-cost carrier.     

A linear programming-based method for the network revenue management problem of air cargo

One critical operational issue of air cargo operation faced by airlines is the control over the sales of their limited cargo space. Since American Airlines’ successful implementation in the post-deregulation era, revenue management (RM) has become a common practice for the airline industry. However, unlike the air passenger operation supported by well-developed RM systems with advanced decision models, the decision process in selling air cargo space to freight forwarders is usually based on experience, without much support from optimization techniques. This study first formulates a multi-dimensional dynamic programming (DP) model to present a network RM problem for air cargo. In order to overcome the computational challenge, this study develops two linear programming (LP) based models to provide the decision support operationally suitable for airlines. In addition, this study further introduces a dynamic adjustment factor to alleviate the inaccuracy problem of the static LP models in estimating resource opportunity cost. Finally, a numerical experiment is performed to validate the applicability of the developed model and solution algorithm to the real-world problems.     

Code sharing,joint fares,and competition in the regional airline industry

In the wake of airline deregulation, virtually all large jet carriers have entered into cooperative marketing agreements that involve shared designator codes and joint fares with commuter airlines. This paper examines the development of these agreements, the role they play in the competitive strategies of major and commuter airlines. and the implications of these agreements for the structure of the airline industry and for service to travelers to and from small communities.     

Is it the labor unions’ fault? Dissecting the causes of the impaired technical efficiencies of the legacy carriers in the United States

Data envelopment analysis is used to evaluate the technical efficiencies of a number of major passenger airlines in the United States at transforming their inputs (labor, fuel and fleet-wide seating capacity) into available seat-miles. A tobit regression model is then used to identify the underlying drivers of airline efficiency, as measured by the data envelopment analysis efficiency score. The impact of unionization on airline efficiency is found to be statistically insignificant, controlling for the influences of other hypothesized determinants of airline efficiency: the average age of an airline’s fleet, the average size of its aircraft, its average stage length, the extent to which the airline relies of hubbing within its route structure, the percent of its passenger enplanements that are international, and whether the airline is a legacy carrier. The statistically significant drivers of airline efficiency, at a ten percent level of significance, are average aircraft size, average stage length and the extent to which the airline relies on hubbing and connecting flights within its route structure. The stage length variable is not significant at a five percent level of significance, however. An increase in average aircraft size or in average stage length enhances an airline’s efficiency whereas an increase in hubbing reduces it.     

Coordinated scheduling models for allied airlines

Recently, as a means of forming global networks and improving operation efficiency, major air carriers have increasingly entered into alliances with other carriers. Fleet routing and flight scheduling are not only important in individual airline operations, but also affect the alliances. The setting of a good flight schedule can not only enhance allied airline operating performance, but can also be a useful reference for alliance decision-making. In this research, we develop several coordinated scheduling models, which will help the allied airlines solve for the most satisfactory fleet routes and timetables under the alliance. We employ network flow techniques to construct the models. The models are formulated as multiple commodity network flow problems which can be solved using a mathematical programming solver. Finally, to evaluate the models, we perform a case study based on real operating data from two Taiwan airlines. The preliminary results are good, showing that the models could be useful for airline alliances.     

A bi-objective dynamic programming approach for airline green fleet planning

Ensuring a fleet of green aircraft is a basic step in mitigating aviation pollution issues that are expected to be worsen in the coming years due to rapid air traffic growth. This study proposed a novel methodology in green fleet planning in which both profit and green performance of airline are considered simultaneously and explicitly. To do this, a Green Fleet Index (GFI) is derived as an indicator to quantify the green performance of airline’s fleet. It measures the degree of airline compliance with a standard requirement in terms of emission, noise, and fuel consumption. A bi-objective dynamic programming model is then formulated to find optimal aircraft acquisition (lease or purchase) decision by minimizing GFI and maximizing profit. Several interesting results are obtained: (1) considering environmental issue as secondary objective yields a greener fleet; (2) airline’s profit is affected, but could be recovered from environmental cost savings; (3) increasing load factor is an effective operational improvement strategy to enhance airline’s green performance and raise profit level. It is anticipated that the framework developed in this study could assist airlines to make a smart decision when considering the need to be green.     

Intercontinental-airport regulation

This paper analyzes strategic interaction between intercontinental airport regulators, each of which levies airport charges paid by airlines and chooses its airport capacity under conditions of congestion. Congestion from intercontinental flights is common across intercontinental airports since departure and arrival airports are linked one to one, while purely domestic traffic also uses each airport. The paper focuses on two questions. First, if both continents can strategically set separate airport charges for domestic and intercontinental flights, how will the outcome differ from the first-best solution? Second, how is strategic airport behavior affected by the extent of market power of the airlines serving the intercontinental market? We see that strategic airport pricing and capacity choices by regulators lead to a welfare loss: the regulators both behave as monopolists in the market for intercontinental flights, charging a mark-up and decreasing capacity. This welfare loss even overshadows possible negative effects from imperfect competition within the intercontinental airline market. We further discuss how the presence of multiple regulators on one continent or a simple pricing rule might constrain the welfare loss created by strategic airport regulation.     

Hub location in the South-Atlantic airline market: A spatial competition game

The paper analyzes the airlines’ hub location problem through a spatial competition game played in two stages. First, airlines sequentially choose the location of their hub and second, they compete offering direct or connecting services between each city-pair. Different outcomes in the first stage will affect competition in the second, and as a consequence, the market share that airlines can obtain.Given actual demand patterns, results of the model are applied to the South-Atlantic airline market. We study the subgame perfect equilibriums obtained as a result of competition in each city-pair to anticipate where airlines will probably locate their hubs once an “open skies” policy is adopted in this market.     

The flight perturbation problem

Airlines spend considerable time, effort and financial resources on planning. It is essential to create a competitive timetable and construct a fleet and a crew schedule that utilizes these resources to the maximum. Unfortunately, it is all too common that an airline is faced with the necessity of reconstructing their schedules due to some unforeseen event, for example an aircraft breakdown or a crew member that is indisposed. In this paper, an application that can help airlines solve the complex problem of reconstructing aircraft schedules is presented. A mixed integer multicommodity flow model with side constraints is developed and further reformulated into a set packing model using the Dantzig—Wolfe decomposition. Cancellations, delays and aircraft swaps are used to resolve the perturbation, and the model ensures that the schedule returns to normal within a certain time. Two column generation schemes for heuristically solving the model are tested on real problem data obtained from a Swedish domestic airline. The computational tests show that the application is capable of presenting high quality solutions in a few seconds and therefore can be used as a dynamic decision support tool by the airlines.     

Airline energy efficiency measures considering carbon abatement: A new strategic framework

In this paper, airline energy efficiency is divided into two stages: Operations Stage and Carbon Abatement Stage. This new two-stage operating framework is a modification of existing ones. Then the model, Network SBM with weak disposability, is presented to evaluate the efficiency of 22 international airlines from 2008 to 2012. The results show that: (1) Most airlines’ energy efficiencies have not declined in the period. (2) The average efficiency of European airlines is higher than that of non-European airlines. (3) Non-European airlines have smaller advancements in efficiency score than European airlines. (4) Most airlines’ efficiencies in Operations Stage are higher than Carbon Abatement Stage.     

Wildlife strike cost revelation in the US domestic airline industry

Since the Federal Aviation Administration (FAA) last revisited its wildlife strike disclosure policy in 2009, the American domestic airline industry has undergone a significant increase in concentration. We analyze how the aforementioned shift in market structure has impacted the voluntary repair cost disclosure of US airlines following a damaging wildlife strike event. We also investigate the related relationship between profitability and disclosure using an instrumental variables strategy. Lastly, we examine the interaction between competition and profits. Our results show the probability of large American airlines disclosing direct repair costs after a wildlife strike event are linked to market competition and profitability. These findings could directly inform policies managing the economic burden of wildlife strikes, most importantly, the current voluntary disclosure policy.