The Two Aspects of Airline Competition
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Pricing and time-differentiation: The two aspects of airline competition Evidence from the Greek market Abstract Airlines compete on multiple aspects. Besides the traditional competition on air fares, airlines take decisions on the time differentiation between their flights and those of their competitors. I examine the Greek airline market from 2009 to 2014. The multiple changes in the competition level of the market let me examine how a transition from a duopoly to i) an oligopoly, ii) a monopoly following a merger or iii) a duopoly with a low-cost airline did affect prices and departure times. The merger of the two leading Greek airlines did not have any significant effects on prices but it increased differentiation on departure times in an attempt cannibalization of products to be prevented. The entry of a third airline in the market had similar results on the incumbent’s competitive behavior as that of a low-cost airline. While departure time differentiation was not altered in both cases, the changes in the competitive framework of the market led to a significant price reduction. Natasha Kalara 10425985 Supervisor: Prof. Maarten Pieter Schinkel Statement of Originality This document is written by Student Anastasia Xanthi Kalara who declares to take full responsibility for the contents of this document. I declare that the text and the work presented in this document are original and that no sources other than those mentioned in the text and its references have been used in creating it. The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents. Table of contents Table of contents ....................................................................................................................... 2 Introduction ............................................................................................................................... 4 Theory of spatial differentiation ............................................................................................... 5 The market ................................................................................................................................ 8 Data ......................................................................................................................................... 12 Measure of departure-time differentiation ............................................................................ 18 The Model ............................................................................................................................... 19 Results ..................................................................................................................................... 24 Conclusion ............................................................................................................................... 26 Further research ...................................................................................................................... 29 References ............................................................................................................................... 30 Annex I ..................................................................................................................................... 35 Annex II .................................................................................................................................... 36 Annex III ................................................................................................................................... 37 Annex IV................................................................................................................................... 39 Annex V .................................................................................................................................... 40 Annex VI................................................................................................................................... 41 Annex VII.................................................................................................................................. 42 Introduction The Greek airline market went through significant changes during the last years. For a long period, various airlines1 repeatedly attempted to break the duopoly of Olympic Air and Aegean Airlines. Following the privatization of Greek flag carrier Olympic Air (formerly Olympic Airlines), the two largest firms of the market tried to merge twice before the European Commission finally approve their plan on the ground of failing firm defense rather than a procompetitive effect reasoning. Even though, Ryanair had previously claimed to have no interest in the Greek market, the low-cost airline entered in 2014. However, its market presence was limited only in certain rather than the total number of routes. Thus, it did not fully restore the previous duopolistic status of the market. These adjustments in the state of the market provided the opportunity to examine how different levels of competition affect the airlines’ behavior. Typically as in other type of markets, airlines compete through the quantity and prices they set. The firms choose the quantity they are offering and simultaneously the prices for their flights. Multiple aspects can affect this process, one of the most important being the market structure and the number of airlines performing in the market. The number of companies that perform in a market plays a crucial role on the level of prices. The importance of an airline’s entry in a market has been examined during the first years of deregulation of the national markets. This action led to increased competition in international and national routes. Various studies have indicated that the entry of a new airline leads to lower prices. Joskow, Werden and Johnson (1994) confirm that the entry reduces airline fares and increases output. However, the incumbents do not increase their output. Hurdle et al. (1989) suggest that the best model for explaining fares is one that takes into account the market concentration for incumbents as well as the number of potential entrants. Graham et al. (1983) examines data from the U.S. airline market and reject the hypothesis that fares are independent of market concentration. Indeed, market concentration affects price levels in multiple ways. Not only an increase in the number of competitors reduces airfares, but also the takeover of a rival can lead to reverse results. Kim and Singal (1993) confirm that prices increased after a merger when comparing a group of routes served by merging firms with a group of unaffected routes. 1 Athens Airways was active in the Greek domestic market in 2009-2010 while Cyprus Airways in 2012-2013. Borenstein (1990) concludes that in addition to increased fares on routes which both merging parts were serving before, increases were further observed on routes with no previous active competition. Various studies examined the results of specific airline mergers and acquisitions (Werden et al, 1991 and Morrison, 1996). Their findings are in accordance with the theory. Nonetheless, the level of fares is not only determined by the presence of potential entrants but also by the operational model of these firms. Low – cost airlines have proven to significantly reduce the level of fares in the markets they enter (Vowles, 2000). Goolsbee and Syverson (2005) study the effects of Southwest Airlines’ entry – the world’s largest low- cost airline – on various city pairs. They confirm that incumbents cut fares significantly when threatened by Southwest’s entry. While firms reduce their prices on the routes where a low- cost carrier entry occurred, they do not increase fares on non-competitive routes to compensate for the lost revenues (Windle & Dresner, 1999). In addition, competition with low-cost airlines reduces significantly all fare types, while competition with conventional carriers leads to only small reductions in the leisure segment and significant reductions on fares for business purposes (Alderighi et al, 2012). The presence of a low-cost airline not only affects indiscriminately types of fares but also types of markets. The effects are significant not only for airport pairs but also for adjacent airports and as potential competition (Brueckner et al, 2013). During the recent years a new aspect of airline competition has come to light: the time of departure and how airlines differentiate on that dimension. Beyond just a price rivalry, airlines have another dimension in which they can set their strategy in comparison to their competitors. In the next chapter I will examine the theoretical framework of spatial differentiation and then I will provide an overview of the studies that examine the concept in respect to airline competition and airlines’ competitive behavior. Theory of spatial differentiation Spatial differentiation is a thoroughly examined aspect of competition. According to Hotelling’s law, firms decide to allocate their shops close to their competitors in order to achieve higher profits through capturing more consumers. Later research indicated that more intense competition can lead in fact to product differentiation (d’Aspremont et al, 1979). Various studies examined the phenomenon for different types of markets such as gasoline stations (Netz and Taylor, 2002). In addition to the conventional spatial differentiation of store allocation, the aspect of differentiation can be expanded to various characteristics of