Strategic Responses to Competitive Threats: Airlines in Action John Kwoka & Birzhan Batkeyev Northeastern University April 16, 2016 John Kwoka & Birzhan Batkeyev Strategic Responses to Competitive Threats
Overview Introduction 1 Related Literature 2 Empirical Methodology 3 United’s Response to Virgin Entry 4 United’s Response to Southwest Entry 5 Conclusion 6 John Kwoka & Birzhan Batkeyev Strategic Responses to Competitive Threats
Entry into Newark Airport Newark Airport is “fortress hub” for United High on list of most constrained airports in U.S. Focus of study is response to Virgin America’s entry (2013) Long sought entry into Newark to connect to hubs on west coast Got 15 slots from bankrupt American in late 2012 In December, announced service to San Francisco, LAX, to start in April 2013, in direct competition with United In early April United announced increased service Daily service to San Francisco increased from 7 to 16 departures Daily service to LAX from 6 to 14 departures Both sides stuck to service increases, prices fell dramatically John Kwoka & Birzhan Batkeyev Strategic Responses to Competitive Threats
Contrast in Airlines, and Studies Key study by Goolsbee and Syverson (2008) analyzes response of various carriers to likely entry by Southwest Defined as Southwest entering airport B when it already served airport A Find evidence of pre-emptive price decreases by carriers already serving A to B Little evidence of capacity increases Our study holds identity of incumbent constant Route, time period also essentially the same Entry triggered by exogenous administrative action Focus on Virgin, but will also examine Southwest’s entry John Kwoka & Birzhan Batkeyev Strategic Responses to Competitive Threats
Entry and Deterrence Modern theories of entry deterrence due to Spence (1977), Dixit (1980) require “Rational” actions by incumbents Sunk investment by incumbent, also by entrant First move by incumbent irreversibly alters game faced by entrant Equilibrium involves greater capacity, some sacrifice of profit, but no entry Other strategies include contractual practices, learning by doing, advertising, switching costs John Kwoka & Birzhan Batkeyev Strategic Responses to Competitive Threats
Empirical Testing Empirical work has lagged Difficult to distinguish pre-emptive entry deterring behavior from ordinary business acts Observationally equivalent Intent unobservable Key empirical approach: Identify circumstances where entry deterring behavior would not be observed For example, when entry is already constrained, acts unlikely to be motivated by entry deterrence Contract with acts under other conditions John Kwoka & Birzhan Batkeyev Strategic Responses to Competitive Threats
Empirical Studies Lieberman (1987) Ellison and Ellison (2011) Dafny (2005) Conlin and Kadiyali (2004) Cookson (2014) Smiley (1988) Goolsbee and Syverson (2008) John Kwoka & Birzhan Batkeyev Strategic Responses to Competitive Threats
Data Sources and Description Data sources are DB1B on tickets and prices T100 on departures and seats Standard screens and filters Time period: 2008.1 to 2014.4 Yields total of 1462 routes served by United 93 routes to/from Newark Virgin launched service on two at Newark Southwest served total of 24 destinations John Kwoka & Birzhan Batkeyev Strategic Responses to Competitive Threats
Model Specification I Model compares United’s response to entry with its actions on Newark routes not subject to entry over same time periods: 5 � y rt = β 0 + β t ( D t × Airline Route r ) + γ X rt + ǫ rt t = − 6 y rt = natural logarithm of market fares, number of departures, and seats for the United Airlines flying route r in quarter t . D t are time dummies surrounding the period when Virgin or Southwest establishes a presence at Newark. Airline Route r are dummies for routes entered by the airline after getting slots at Newark. X rt is a vector of controls which includes origin and destination HHI, route concentration, non-stop miles between the airports, carrier-route and carrier-quarter fixed effects. John Kwoka & Birzhan Batkeyev Strategic Responses to Competitive Threats
United’s Response to Virgin Entry on (EWR-SFO) I John Kwoka & Birzhan Batkeyev Strategic Responses to Competitive Threats
United’s Response to Virgin Entry on (EWR-SFO) II ln(Price) ln(Departures) ln(Seats) Virgin Route - not flying ( t 0 − 6 ) 0.049* 0.263 0.275* (0.029) (0.168) (0.162) Virgin Route - not flying ( t 0 − 5 ) -0.019 0.209 0.209 (0.024) (0.165) (0.160) Virgin Route - not flying ( t 0 − 4 ) 0.031 0.567*** 0.624*** (0.021) (0.158) (0.157) Virgin Route - not flying ( t 0 − 3 ) 0.174*** 0.744*** 0.732*** (0.022) (0.175) (0.170) Virgin Route - not flying ( t 0 − 2 ) 0.113*** 0.576*** 0.492*** (0.027) (0.152) (0.144) Virgin Route - not flying ( t 0 − 1 ) 0.225*** 0.497*** 0.468*** (0.027) (0.182) (0.181) Virgin Route - entered ( t 0 ) -0.123*** 0.876*** 0.861*** (0.031) (0.154) (0.152) Virgin Route - flying ( t 0 + 1 ) -0.173*** 1.593*** 1.541*** (0.032) (0.234) (0.226) Virgin Route - flying ( t 0 + 2 ) -0.165*** 1.420*** 1.400*** (0.039) (0.201) (0.196) Virgin Route - flying ( t 0 + 3 ) -0.220*** 1.021*** 0.988*** (0.032) (0.209) (0.206) Virgin Route - flying ( t 0 + 4 ) -0.151*** 1.480*** 1.457*** (0.030) (0.203) (0.197) Virgin Route - flying ( t 0 + 5 ) -0.068** 1.355*** 1.308*** (0.032) (0.187) (0.180) Carrier-Route FE Yes Yes Yes Carrier-Quarter FE Yes Yes Yes Year-Quarter FE Yes Yes Yes R 2 0.792 0.898 0.903 Observations 1329 1329 1329 John Kwoka & Birzhan Batkeyev Strategic Responses to Competitive Threats
United’s Response to Virgin Entry on (EWR-LAX) I John Kwoka & Birzhan Batkeyev Strategic Responses to Competitive Threats
United’s Response to Virgin Entry on (EWR-LAX) II ln(Price) ln(Departures) ln(Seats) Virgin Route - not flying ( t 0 − 6 ) -0.137*** 0.146 0.153 (0.028) (0.190) (0.183) Virgin Route - not flying ( t 0 − 5 ) -0.210*** 0.079 0.069 (0.024) (0.168) (0.163) Virgin Route - not flying ( t 0 − 4 ) -0.117*** 0.522*** 0.523*** (0.023) (0.170) (0.169) Virgin Route - not flying ( t 0 − 3 ) 0.059** 0.623*** 0.557*** (0.025) (0.206) (0.201) Virgin Route - not flying ( t 0 − 2 ) 0.013 0.451** 0.350** (0.024) (0.178) (0.170) Virgin Route - not flying ( t 0 − 1 ) 0.046* 0.491** 0.455** (0.027) (0.214) (0.214) Virgin Route - entered ( t 0 ) -0.162*** 0.771*** 0.711*** (0.025) (0.158) (0.153) Virgin Route - flying ( t 0 + 1 ) -0.180*** 1.242*** 1.155*** (0.029) (0.221) (0.211) Virgin Route - flying ( t 0 + 2 ) -0.213*** 1.250*** 1.175*** (0.030) (0.193) (0.187) Virgin Route - flying ( t 0 + 3 ) -0.247*** 0.950*** 0.874*** (0.026) (0.209) (0.205) Virgin Route - flying ( t 0 + 4 ) -0.155*** 1.309*** 1.247*** (0.022) (0.194) (0.188) Virgin Route - flying ( t 0 + 5 ) -0.056** 1.118*** 1.003*** (0.023) (0.170) (0.163) Carrier-Route FE Yes Yes Yes Carrier-Quarter FE Yes Yes Yes Year-Quarter FE Yes Yes Yes R 2 0.792 0.897 0.903 Observations 1329 1329 1329 John Kwoka & Birzhan Batkeyev Strategic Responses to Competitive Threats
Implications Little evidence of pre-emption by United No indication of price change Slight change in capacity, but causation unclear But, capacity increased dramatically after entry Why capacity? Why not before? Would this persist? What was purpose? Results differ from Goolsbee and Syverson (2008) Due to exogenous nature of entry? John Kwoka & Birzhan Batkeyev Strategic Responses to Competitive Threats
United – Southwest Condition of approval of United-Continental merger (2010) was slot divestiture to LCC Southwest acquired slots at Newark Southwest initiated service in early 2011 To two United hub cities But Midway, not O’Hare in Chicago Hobby, not Houston Intercontinental Also, to St. Louis, Lexington KY, other destinations John Kwoka & Birzhan Batkeyev Strategic Responses to Competitive Threats
United on EWR-ORD to Southwest Entry to EWR-MDW ln(Price) ln(Departures) ln(Seats) Southwest Route - not flying ( t 0 − 6 ) -0.139*** -0.097 -0.089 (0.018) (0.154) (0.149) Southwest Route - not flying ( t 0 − 5 ) -0.147*** 0.068 0.014 (0.023) (0.162) (0.157) Southwest Route - not flying ( t 0 − 4 ) -0.056*** -0.364** -0.437*** (0.022) (0.167) (0.159) Southwest Route - not flying ( t 0 − 3 ) 0.071** -0.163 -0.191 (0.029) (0.181) (0.182) Southwest Route - not flying ( t 0 − 2 ) 0.018 0.106 0.086 (0.025) (0.157) (0.156) Southwest Route - not flying ( t 0 − 1 ) 0.023 0.038 -0.008 (0.022) (0.144) (0.136) Southwest Route - entry ( t 0 ) 0.014 0.079 0.070 (0.029) (0.147) (0.141) Southwest Route - flying ( t 0 + 1 ) -0.118*** -0.112 -0.078 (0.021) (0.156) (0.152) Southwest Route - flying ( t 0 + 2 ) -0.094*** 0.010 -0.044 (0.022) (0.177) (0.171) Southwest Route - flying ( t 0 + 3 ) -0.146*** -0.175 -0.224 (0.029) (0.172) (0.164) Southwest Route - flying ( t 0 + 4 ) -0.035 -0.267** -0.248* (0.024) (0.131) (0.127) Southwest Route - flying ( t 0 + 5 ) 0.008 -0.064 -0.019 (0.023) (0.142) (0.144) Carrier-Route FE Yes Yes Yes Carrier-Quarter FE Yes Yes Yes Year-Quarter FE Yes Yes Yes R 2 0.791 0.897 0.902 Observations 1329 1329 1329 John Kwoka & Birzhan Batkeyev Strategic Responses to Competitive Threats
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