Patterns and Effects of Entry in U.S. Airline Markets

The importance of market entry for competition and innovation is largely undisputed in the field of industrial organisation. Following the well-known methodology of Paul Geroski (1991, 1995), this importance is based on two major roles of entry: as an equilibrium force in that it competes away excess profits to an equilibrium level (so-called imitative entry) and as a disequilibrium force which propels the industry from one equilibrium state to another due to the introduction and diffusion of innovations (so-called innovative entry). The U.S. airline industry can act as a prime example for the relevance of both types of entry. On the one hand, since the deregulation of the industry in 1978 imitative entry into many routes significantly increased competitive pressures and forced the traditional network carriers to increase their productive efficiency leading to lower fares and better service on many routes. On the other hand, deregulation allowed the appearance and growth of low-cost carriers who challenge the traditional network carriers with various forms of innovative entry. Against this background, we use T-100 traffic data and DB1B fare data from the U.S. Department of Transportation to identify patterns and effects of entry by network carriers and low-cost carriers in non-stop U.S. airline markets. For the sample period from 1996 to 2009, we find significant entry activity for both network carriers and low-cost carriers. However, while the network carriers showed substantial entry activity between 1996 and 2000, the average number of entries dropped significantly from 2003 onwards. Since 2004, the group of low-cost carriers entered more markets per year than the group of network carriers. In addition, the analysis revealed that low-cost carrier entries have significantly higher survival rates than entries by network carriers. With respect to the effects of entry, we apply two different approaches: a descriptive approach which studies the effects of all entry events in the TOP 500 non-stop U.S. airline markets and an econometric approach which investigates the effects of entry into existing non-stop markets for selected LCCs and NWCs separately by using logarithmic fixed effects regressions. We find that entry activity of low-cost carriers did not only experience significant absolute increases but also led to substantial fare reductions. As route entries by network carriers do not have comparable effects, the existence and expansion of low-cost carriers must be considered as the main driver of (price) competition in the domestic U.S. airline industry.

Hüschelrath, Kai and Kathrin Schopen (2011), Patterns and Effects of Entry in U.S. Airline Markets, ZEW Discussion Paper No. 11-059, Mannheim, published in: Journal of Industry, Competition and Trade.