The Leader's Curse in the Airline Industry

This paper studies the e ect of the airline industry's operational time-line on multi-market competition and carrier network structure selection. Airline carriers typically commit to a rigid capacity of seats via the planned ights schedule long before market competition for selling these seats begins. While in regular markets such a two stage setting has no e ect on competitive behavior, the airline industry has two important features that give rise to strategic interactions. First, the network structure: while direct carriers' capacity decisions are on a route level, hub carriers capacity decisions are on a hub-spoke level, giving hub carriers much exibility in the utilization of allocated capacity. This extra exibility is a double-edged sword while hub carriers are better able to adjust to market shocks, direct carriers enjoy a market leadership advantage, analogous to Stackelberg leadership. This e ect is especially important when markets are asymmetric (e.g. of di erent sizes) as it allows the direct carriers to focus on the larger and more pro table routes. Second, the airline industry exhibits multi-market competition a handful of carriers serve thousands of markets. Coupled with the timing of capacity choice, multi-market competition makes rms with smaller networks more aggressive. Intuitively, a small carrier servicing only a handful of cities has no choice but to utilize his capacity in that small set of routes. If the small carrier places excessive capacity on his routes, a large hub carrier would use its exibility and redirect his installed capacity to other, less aggressive routes. Small carriers allow themselves to be overly aggressive because they do not internalize the e ect of the large carriers reaction on other markets. We cite empiric evidence from existing studies that support of our theoretic results. More speci c empiric tests are in progress. ∗Northwestern University email: [email protected] †IDC, Hertzliya email: [email protected] ‡Northwestern University email: [email protected]