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In addition to domestic mergers and acquisitions, the commercial aviation industry has undergone international integration. The three major airline alliances are admitting new members and have obtained antitrust immunity for their joint ventures. This article is an empirical examination of the impact of international airline alliances on airfares.

Economic Incentives behind Codesharing

An alliance enables its members to benefit from network and frequency expansion. Consider a Chicago–Delhi–Mumbai itinerary where American Airlines (AMR) and Jet Airways operate the first and second segments, respectively. It is advantageous for American to codeshare since the passenger does not fly with American if the Delhi–Mumbai segment is not offered. The gains from codesharing are less obvious in the case of an American-marketed New York–Berlin itinerary operated by Air Berlin. Despite not receiving any ticket revenue (other than an insignificant marketing commission), the partnership broadens American’s network, and strengthens the carrier’s competitive position in the New York market. A traveler may earn frequent flyer miles on domestic flights, and redeem miles on the Air Berlin flight.

Codesharing entails cooperating to route passengers through a hub, and enables partners to profit from the lower unit costs of bigger aircraft, also referred to as economies of density. For instance, United Airlines (NYSE:UAL) cooperates with Lufthansa to flow transatlantic passengers through Washington-Dulles and Frankfurt. In addition to making possible the provision of relatively frequent service, the partnership enables the use of large widebody aircraft.

The elimination of double marginalization is another important benefit of codesharing. In the absence of a codeshare agreement, each carrier of a multi-segment itinerary sets a profit-maximizing price for their specific segment. As a result, the itinerary price is higher than that which would prevail under a single decision maker.

The Effects of Alliances on Airfares

There is no a priori relation between codesharing and complementary route airfares. The economies of density, as well as the elimination of double marginalization, should bring about a fall in ticket prices. However, a passenger could be willing to pay more for service improvements (one-stop check-in, convenient scheduling, fewer frequent flyer program restrictions, etc.). An empirical investigation is needed to determine the net effect.

The authors use the following taxonomy to investigate the difference between through-ticket airfares and sum-of-segments ticket prices:

  • A pure online itinerary is a multi-segment itinerary operated and marketed by the same carrier from origin to destination. For example, the itinerary Boston–Houston–Mexico City operated and marketed by United would be pure online.
  • An allied interline itinerary is a multi-segment itinerary which involves transfers between airlines participating in the same alliance. In the case of an Austin–Detroit–Paris–Bordeaux itinerary, Delta Air Lines only flies the first two segments as the Paris–Bordeaux flight is operated by SkyTeam partner Air France.
  • A non-allied interline itinerary is a multi-segment itinerary which involves transfers between airlines not participating in the same alliance. For instance, the itinerary Memphis–Charlotte–Munich where Delta and Lufthansa operate the first and second segments, respectively, would be non-allied interline.

The results of the regression model are presented in Table 1. Note that (i) the dependent variable is the ratio of through-ticket airfares to sum-of-segments ticket prices, and (ii) the base level is the pure online ratio.


(Click to enlarge)

The results suggest that Star Alliance and SkyTeam members obtain a “service premium” which offsets the effects of double marginalization and economies of density. An alternate explanation is that Star and SkyTeam carriers have yet to achieve the full cost benefits of operation integration, or completely eliminate the effects of double marginalization (the sample data is from the third quarter of 2007). The authors posit that the revenue disadvantage of oneworld members is due to their smaller market presence in the northern transpacific market (the only market sampled). Moreover, note that the Alliance HHI (Herfindahl–Hirschman index) coefficient is positive, and indicates that the entrance of new members should increase the ratio.

The authors also study the impact on the different booking categories. Given the positive coefficients of First Class Bookings and Business Class Bookings, and negative coefficients for economy class bookings, it is concluded that the international business passenger is charged a significantly higher price for through-tickets than the leisure traveler. The greater spread between through-ticket and sum-of-segments airfares is consistent with the idea that the international business traveler is less price-sensitive, and willing to pay a service premium.

Conclusion

The impact of international cooperation on airfares depends on the net effect of economies of density, the elimination of double marginalization, and service improvements. Empirical evidence suggests that Star Alliance and SkyTeam carriers provide improved services which counteract the negative effects of economies of density and the elimination of double marginalization. Moreover, it is found that international business passengers are willing to pay significantly more for through-tickets than leisure travelers. Arguably, the study supports United CEO Jeff Smisek’s intention to “have the domestic [operations] sized solely to feed the international traffic.”

Source: The Effects Of Airline Alliances On Airfares