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The Role of Pricing Strategy in Market Defense A THE ROLE OF PRICING STRATEGY IN MARKET DEFENSE A Dissertation Presented to The Academic Faculty by Can Uslay In Partial Fulfillment of the Requirements for the Degree Doctor of Philosophy in Management Georgia Institute of Technology April, 2005 THE ROLE OF PRICING STRATEGY IN MARKET DEFENSE Approved by: Dr. Naresh K. Malhotra, Advisor Dr. Fred C. Allvine College of Management College of Management Georgia Institute of Technology Georgia Institute of Technology Dr. Pat H. Dickson Dr. Jagdish N. Sheth College of Management Goizueta School of Business Georgia Institute of Technology Emory University Dr. Richard D. Teach College of Management Date Approved: April 6, 2005 Georgia Institute of Technology ACKNOWLEDGEMENT This work is dedicated to my parents, Dr. Yuksel and Nezihe Uslay. I would like to express my heart-felt thanks to all of my dissertation committee members. This dissertation would not have been possible without the ample guidance and support from Professors Fred C. Allvine, Naresh K. Malhotra, Richard D. Teach, Pat H. Dickson, and Jagdish N. Sheth. I cannot thank them enough, but let me attempt to capture my gratitude with a few words here. Every student is lucky to have a mentor but I was lucky to have not one but five of them! Dr. Dickson provided the kind of constructive and useful feedback every doctoral candidate needs. Dr. Teach always had time for me when I needed guidance and advice. Dr. Allvine’s enthusiasm on the use of price in competitive interaction was critical for my choice of the dissertation topic, and his industry contacts proved crucial in securing the data. He has always trusted, supported me and served as a role model. Every minute spent with the great Dr. Sheth has been inspiring and his vision influenced my work and life in more ways than even he could imagine. Last and certainly the most, I would like to thank my advisor, Dr. Malhotra. He simply is a true mentor. I would also like to thank Dr. Goutam Challagalla, Nancy Wong, Charles Parsons, Robert G. Hawkins, Francis M. Ulgado, Alka Citrin, Koert van Ittersum, and my friends Tracey King, Brian Murtha, Leslie Vincent, Lan Wu, and Tim Quey who have provided useful comments, feedback and camaraderie along the way. Naturally, I take full credit for any errors that may remain in this work. iii TABLE OF CONTENTS ACKNOWLEDGEMENT iii LIST OF TABLES viii LIST OF FIGURES xi SUMMARY xiii CHAPTER 1: INTRODUCTION 1 CHAPTER 2: THEORETICAL BASE AND CONCEPTUAL UNDERSTANDING 5 2.1 Competitive Signaling 5 2.2 Resource Advantage (R-A) Theory 8 2.3 Game Theory 11 2.4 Marketing Strategy 13 2.4.1 Reputation effects from a marketing perspective 16 2.4.2 Inter-type and intra-type competition 22 2.4.2.1 Mutual Forbearance 24 CHAPTER 3: AN INQUIRY OF THE USE OF PREDATORY PRICING IN MARKET DEFENSE: EVOLUTION, REVIEW, AND MARKETING SYNTHESIS 27 3.1 Introduction to the Review 27 3.2 Pricing 32 3.2.1 Predatory Pricing 36 3.2.2 Predatory Pricing versus Predation 39 3.3 Evolution of the Theory and Practice of Predatory Pricing 41 3.3.1 A Historical Perspective 41 3.3.2 Regulatory Acts Regarding Predatory Pricing 45 3.3.3 Early Years and the Populist Era (1890-1975) 48 3.3.4 Areeda-Turner Era (1975-1982) 49 iv 3.3.4.1 Counter Cost and Non-cost Proposals 51 3.3.5 Augmented Average Variable Cost Rule Era (1982-1992) 55 3.3.6 Recoupment Requirement Era (1993- ) 56 3.3.6.1 Brooke Case 57 3.3.7 The Emerging School of Thought 59 3.3.8 Differing Practices among States 62 3.3.9 Insights from European Union Regulation 63 3.4 Critical Cases for the Evolution of Case Law 64 3.4.1 Standard Oil (1911) 65 3.4.2 Utah Pie (1967) 66 3.4.3 Matsushita (1986) 67 3.4.4 Rose Acre (1989) 68 3.4.5 Brooke (1993) 69 3.4.6 American Airlines (2001) 71 3.5 Legal Elements of Proof 73 3.6 The State of the Debate on Predatory Pricing 78 3.6.1 The Chicago School 78 3.6.2 The Post-Chicago School of Thought 84 3.7 Synthesis and a Marketing Perspective 92 3.7.1 The Need for a Marketing Perspective 92 3.7.2 A Focus on Deregulated Industries 93 3.7.3 Epilogue 95 3.7.4 Reaction Framework for Competitive Price Reductions 104 CHAPTER 4: NETWORK PRICE COMPETITION FRAMEWORK 107 4.1 Network Industries 111 4.2 Hypotheses 114 4.2.1 Pre-emptive Defense 114 4.2.1.1 Market Power 114 4.2.1.2 Barriers to Entry 118 4.2.1.3 Strategic Assessment 121 4.2.2 Entry Decision 122 4.2.3 Post-Entry Defense 126 4.2.4 Exit Decision 128 4.2.5 Policy Consequences 129 4.2.5.1 Consumer Welfare 131 v CHAPTER 5: CONTEXT: AN INQUIRY OF THE DYNAMICS OF COMPETITION IN THE U.S. AIRLINE INDUSTRY 137 5.1 Historical Perspective 138 5.1.1 The Propeller (Early) Era 140 5.1.2 The Jet (Post-war) Era 146 5.1.3 Deregulation Era 147 5.1.4 Consequences 151 5.1.4.1 Service and Quality 152 5.1.4.2 Fare Levels 155 5.1.4.3 Market Concentration and Power 159 5.1.4.4 Hub-and-Spoke Networks 161 5.1.4.5 Hub Premiums 164 5.1.5 Marketing 167 5.1.5.1 Yield (Revenue) Management 167 5.1.5.2 Frequent Flier Programs 169 5.1.5.3 The Rise (and Fall) of Travel Agents 170 5.1.5.3.1 Computer Reservation Systems (CRS) 172 5.1.5.4 Discounting and Competition 174 5.1.5.5 Price Wars 181 5.2. Competitive Outlook 185 5.2.1 Industry Snapshot 185 5.2.2 The Role of Barriers to Entry 196 5.2.3 After September 11, 2001 200 5.2.3.1 Anticipating Trends 202 5.2.4 European Landscape 206 CHAPTER 6: DATA AND METHODOLOGIES 208 6.1 Data Set 208 6.2 Methodologies 209 6.2.1 Logit Models 210 6.2.2 Multi-Level Mixed Coefficient Model (HLM) 212 6.2.3 Event-History Analysis 215 6.3 Measures 219 CHAPTER 7: DATA ANALYSIS AND RESULTS 224 CHAPTER 8: CONTRIBUTIONS 242 8.1 Managerial Implications 246 vi 8.2 Public Policy Implications 248 8.3 Limitations and Future Research 251 8.4 Conclusion 256 APPENDIX A: Survey of State Law regarding Predatory Pricing 258 APPENDIX B: Comparison of HHI and Proposed MP Index 260 APPENDIX C: U.S. Regional and Major Airline Hubs 265 APPENDIX D: Gate Usage at Large Hubs 1998 266 APPENDIX E: Transformations and Other Analyses 267 APPENDIX F: HLM Analysis Supplements 272 APPENDIX G: Logit Analysis Statistics 274 APPENDIX H: Event-History Analysis Supplements 276 APPENDIX I: Overview of Relevant Empirical Research in the Airline Industry 280 APPENDIX J: Graphical Representation of Inter-Type Competition 288 REFERENCES 293 vii LIST OF TABLES Table 2.1: The Pedigree of Resource Advantage Theory 8 Table 2.2: Characteristics of Intra-type versus Inter type Competition 23 Table 2.3: Non-competitive Pricing among Intra-type Competitors in the Airline Industry 24 Table 3.1: A Summary of the Evolution of Predatory Pricing in the U.S. 42 Table 3.2: Criticisms regarding the Areeda-Turner rule and the Chicago School 96 Table 4.1: Dimensions of Consumer Welfare and Marketing Insights 131 Table 4.2: Summary of the Framework Premises 136 Table 5.1: The U.S. Airline Industry Timetable 139 Table 5.2: Airline Mergers in the 1985-87 Period 160 Table 5.3: Single Carrier Market Shares at Major Airports Pre and Post Deregulation 163 Table 5.4: Changes in Hub Premiums over Time 165 Table 5.5: Sample HHI Index for the 10 largest US Airports 1985-1996 166 Table 5.6: A Comparison of Major Frequent Flier Programs 169 Table 5.7: 1999 Market Share for CRS 173 Table 5.8: Average Fares in Markets With and Without Low-Fare Competition 178 Table 5.9: Average Fares Sorted by Distance 178 Table 5.10: Atlanta Markets with AirTran Entry 179 Table 5.11: Atlanta Markets with AirTran Exit 179 Table 5.12: Airports with Most U.S. Destinations Served by Low Fare Airlines 180 viii Table 5.13: The Cyclical Nature of the U.S. Airline Industry 186 Table 5.14: Aggregate Industry Snapshot Over time 188 Table 5.15: American Airlines’ Actions Relevant for the DOJ Lawsuit 193 Table 5.16: Percentage of Domestic Air Carrier Slots Held by Selected Groups 199 Table 5.17: Direct Aids to Major Airlines by the Federal Government 200 Table 6.1: Contents of O&D databases 209 Table 6.2: Comparison of Alternative Methodologies 218 Table 7.1: Multiple Linear Regression Results 227 Table 7.2: Main Logit Model Results 228 Table 7.3: Logit Model Results for Alternative Cut-off Points 229 Table 7.4: Main HLM Results 232 Table 7.5: Logit Model Results for Hypotheses 8 and 9 233 Table 7.6: Logit Model Classification Table 234 Table 7.7: MLR Results for Hypothesis 10 235 Table 7.8: Logit Analysis Results for Hypotheses 11 and 12 236 Table 7.9: Bivariate Correlations for Hypotheses 11 and 12 238 Table 7.10: Cox Regression Results for Hypothesis 11 and 12 238 Table 7.11: Summary of Results 239 Table 8.1: Overall Contributions through Key Marketing Concepts, Methods, and Data Sources 244 Table 8.2: Issues/Research Perspectives on the Use of Pricing Strategy in Market Defense 255 Table A1: Predatory Pricing Survey 258 ix Table B1: Bivariate Correlations with Full Sample 262 Table B2: Bivariate Correlations with Final Sample 263 Table E1: Correlation Table 270 Table E2: MLR Model results with full sample 270 Table E3: Reduced MLR Model Results 271 Table G1: Results with Dummy Variables 274 Table H2: Event-History Analysis 279 Table I1: Overview of Relevant Empirical Research in the Airline Industry 280 x LIST OF FIGURES Figure 2.1: A Simple Game-Theoretic Construct in the Airline Context 13 Figure 2.2: A Typology of Reputation and Image 18 Figure 2.3: Framework for Assessing the Incumbent’s Reputation for 21 Predation and its Impact on Market Entry Figure 3.1: Perception of Predatory Pricing under Current Law 38 Figure 3.2: Approximated Predatory Pricing Plaintiff Court Success over Time 44 Figure 3.3: Cost Relationships 50 Figure 3.4: Decision-Making Framework in the U.S.
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