kiS5 Be EUROPEAN UNIVERSITY INSTITUTE Department of Economics Intra-European Airline Competition: A Theoretical and an Empirical Analysis Giovanni Nero Thesis submitted for assessment with a view to obtaining the Degree of Doctor of the European University Institute Florence, December 1995 EUROPEANllllIlllliNlllll UMVERSmr INSTITUTE I ^ 3 0001 0023 2145 5 k>S£0 EUROPEAN UNIVERSITY INSTITUTE Department of Economics Intra-European Airline Competition: A Theoretical and an Empirical Analysis Giovanni Nero If LIB 387.714 NER The Thesis Committee consists of: Prof. David Encaoua, University of Paris I “ Ulrich Kohli, University of Geneva “ Stephen Martin, University of Copenhagen and EUI “ Jacques Pavaux, University of Toulouse “ Louis Phlips, EUI, Supervisor Contents Acknowledgement vii Introduction 1 1 European Airline Regulation and Empirical Evidence of Some European Airlines Networks 6 1.1 Introduction........................................................................................ 6 1.2 The Regulatory Environment.......................................................... 7 1.2.1 The Ancient Regim e............................................................. 7 1.2.2 The New Regime................................................................... 8 1.3 Empirical Evidence of some European Airlines Networks............ 12 1.3.1 Preliminary Comments.......................................................... 12 1.3.2 Methodology and D ata.......................................................... 14 1.4 Austrian Airlines (OS) Network’s Characteristics ......... 16 1.4.1 Network Description............................................................. 16 1.4.2 Austrian Domestic Market.................................................... 19 1.4.3 OS’s Intra-European Market................................................. 20 1.5 Swissair (SR) Network’s Characteristics.......................................... 23 1.5.1 Network Description............................................................. 23 1.5.2 Swiss Domestic Market.......................................................... 25 1.5.3 The intra-European Market ................................................. 26 1.6 KLM (KL) Network’s Characteristics............................................. 29 1.6.1 Network Description............................................................. 29 1.6.2 Dutch Domestic M arket....................................................... 31 1.6.3 The Intra-European Market................................................ 32 1.7 SAS (SK) Network’s Characteristics................................................ 35 1.7.1 Network Description............................................................. 35 1.7.2 Scandinavian Domestic M arket........................................... 37 1.7.3 The Intra-European M arket................................................. 39 1.8 Conclusion........................................................................................... 44 1.9 References........................................................................................... 45 1.10 Appendix........................................................................................... 46 2 A Structural Model of Intra-European Airline Competition 50 2.1 Introduction........................................................................................ 50 2.2 Assumptions and Model S et-up....................................................... 51 2.3 The Collusive Agreements Sélution.......................................... 56 2.4 The Noncooperative Solution ................................................... 60 2.5 The Collusive Versus the Noncooperative Solution................... 63 2.6 The Merger Solution................................................................... 66 2.7 The Merger Versus the Noncooperative Solution.................... 71 2.8 Conclusion........................................................................................... 74 2.9 References........................................................................................... 75 2.10 Appendix........................................................................................... 77 2.10.1 Second Order Conditions for the Collusive Solution .... 77 2.10.2 Proof of Proposition 1 ........................................................... 77 2.10.3 Proof of Proposition 2 .......................................................... 78 2.10.4 Second Order Conditions for the Noncooperative Solution 78 2.10.5 Proof of Proposition 3 ........................................................... 78 2.10.6 Proof of Proposition 4 ........................................................... 79 2.10.7 Proof of Proposition 5 ........................................................... 79 2.10.8 Second Order Conditions for the Merger Solution............ 80 2.10.9 Proof of Proposition 6 ........................................................... 80 2.10.10 Proof of Proposition 7 ........................................................... 80 2.10.11 Proof of Proposition 8 .......................................................... 81 3 Third Package, Lack of Entry and Noncooperative Collusion in the European Airline Industry 85 3.1 Introduction......................................................................................... 85 3.2 Lack of Entry in Intra-EU Airline M arkets...................................... 88 3.2.1 Reactions to the New Regulatory Environment................... 88 3.2.2 Strategic Interactions in the Airline Industry...................... 92 3.3 The Model............................................................................................ 94 3.3.1 Assumptions and Model Set-up........................................... 94 3.3.2 Specifications.......................................................................... 100 3.4 Results.................................................................................................. 103 3.4.1 GAME I: Partial Liberalisation ............................................ 103 3.4.2 GAME II: Complete Liberalisation..................................... 108 3.4.3 Illustration and Numerical Example..................................... 113 3.5 Concluding Remarks......................................................................... 114 3.6 References............................................................................................ 116 3.7 Appendix............................................................................................ 119 4 Spatial Multiproduct Duopoly with Finite and Small (Enough) Reservation Price 121 4.1 Introduction....................................................................................... 121 4.2 Spatial Competition and Models of Product Differentiation: Some Basic Definitions................................................................................ 122 ii 4.3 The Assumptions of the Spatial Setting......................................... 124 4.4 Proof................................................................................................... 128 4.4.1 The Second Stage Price Equilibrium.................................. 128 4.4.2 The First Stage Location Equilibrium................................. 128 4.4.3 The Scope Decision................................................................ 129 4.5 Conclusion.......................................................................................... 133 4.6 References.......................................................................................... 134 4.7 Appendix.......................................................................................... 135 4.7.1 The Two Outlet Case............................................................. 135 4.7.2 The One Outlet Case............................................................ 136 Spatial Multiproduct Pricing: Theory and Empirical Evidence on the Intra-European Duopoly Airline Markets 137 5.1 Introduction....................................................................................... 137 5.2 Price Competition and Location Choice in Multiproduct Duopoly 139 5.3 Spatial Multiproduct Duopoly Pricing: The Two-Outlet Case . 143 5.3.1 The Interlaced Outlet Equilibrium .................................... 143 5.3.2 The Neighbouring Outlet Equilibrium................................. 145 5.3.3 Comparison of the Various Equilibrium Patterns in the Two- Outlet C ase............................................................................ 146 5.4 Spatial Multiproduct Duopoly Pricing: The Three-Outlet Case . 148 5.4.1 The Interlaced Outlet Equilibrium .................................... 148 5.4.2 The Neighbouring Outlet Equilibrium................................. 150 5.4.3 The Mixed Outlet Equilibrium............................................. 152 5.4.4 Comparison of the Various Equilibrium Patterns in the Three- Outlet C ase............................................................................ 155 5.5 A Model for Comparing Prices Across Airline Markets with Diffe­ rent Location Patterns...................................................................... 158 5.5.1 Introduction............................................................................ 158 5.5.2 The Theoretical Structure................................................... 160 5.5.3 The Data and the Econometric Specification.................... 165 5.5.4 The Empirical Findings ...................................................... 170 5.6 Concluding Remarks.........................................................................