Wednesday, June 8, 2011

INSEAD Working Paper 2011/24/TOM/ACGRE

The formation of an airline alliance is one of the most important and difficult decisions that has to be made by airline management. In particular, domestic airline alliances have always caused controversy due to the possibility of attenuating the competition, which has been a key concern of policy makers. Before approving such alliances, government authorities therefore pay a lot of attention to how many overlapping routes the two airlines attempting to join forces already have. In this paper we go beyond this point of view and attempt to understand the competitive effects of domestic alliances by analyzing how ight networks change dynamically after an alliance. We analyze six major US airlines from 1998 to 2006 and estimate the changes in their entry/exit/stay behavior by adopting a concept analogical to the \difference-in-difference" estimation approach. We show that, in the post-alliance era, airlines are more likely to enter/stay and build higher capacity in markets where their alliance partners hold strong market power, compared to markets where non-partners dominate. We show that this tendency is likely to be induced by higher pricing power in the markets dominated by the alliance partners rather than by higher demand in those markets. In a typical duopoly market, the two allied partners are able to charge nearly $9 more per one-way ticket coupon as compared to  non-allied competitors. Our findings have important implications for both policy makers and airline practitioners. In addition to reviewing the current overlapping routes before an alliance, it is crucial for policy makers to be aware of how airlines may change their networks dynamically after the alliance, and how this will affect the competition structure. We also find that the allied airlines may have been over-optimistic about the demand-increasing effect of alliances on markets shared with partners, since we find a decrease in load-factors in these markets.