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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

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SLIDE 1

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

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SLIDE 2

Overview

1

Introduction

2

Related Literature

3

Empirical Methodology

4

United’s Response to Virgin Entry

5

United’s Response to Southwest Entry

6

Conclusion

John Kwoka & Birzhan Batkeyev Strategic Responses to Competitive Threats

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SLIDE 3

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

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SLIDE 4

Contrast in Airlines, and Studies

Key study by Goolsbee and Syverson (2008) analyzes response

  • f 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

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SLIDE 5

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

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SLIDE 6

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

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SLIDE 7

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

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SLIDE 8

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

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SLIDE 9

Model Specification I

Model compares United’s response to entry with its actions on Newark routes not subject to entry over same time periods: yrt = β0 +

5

  • t=−6

βt(Dt × Airline Router) + γXrt + ǫrt yrt = natural logarithm of market fares, number of departures, and seats for the United Airlines flying route r in quarter t. Dt are time dummies surrounding the period when Virgin or Southwest establishes a presence at Newark. Airline Router are dummies for routes entered by the airline after getting slots at Newark. Xrt 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

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SLIDE 10

United’s Response to Virgin Entry on (EWR-SFO) I

John Kwoka & Birzhan Batkeyev Strategic Responses to Competitive Threats

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SLIDE 11

United’s Response to Virgin Entry on (EWR-SFO) II

ln(Price) ln(Departures) ln(Seats) Virgin Route - not flying (t0 − 6) 0.049* 0.263 0.275* (0.029) (0.168) (0.162) Virgin Route - not flying (t0 − 5)

  • 0.019

0.209 0.209 (0.024) (0.165) (0.160) Virgin Route - not flying (t0 − 4) 0.031 0.567*** 0.624*** (0.021) (0.158) (0.157) Virgin Route - not flying (t0 − 3) 0.174*** 0.744*** 0.732*** (0.022) (0.175) (0.170) Virgin Route - not flying (t0 − 2) 0.113*** 0.576*** 0.492*** (0.027) (0.152) (0.144) Virgin Route - not flying (t0 − 1) 0.225*** 0.497*** 0.468*** (0.027) (0.182) (0.181) Virgin Route - entered (t0)

  • 0.123***

0.876*** 0.861*** (0.031) (0.154) (0.152) Virgin Route - flying (t0 + 1)

  • 0.173***

1.593*** 1.541*** (0.032) (0.234) (0.226) Virgin Route - flying (t0 + 2)

  • 0.165***

1.420*** 1.400*** (0.039) (0.201) (0.196) Virgin Route - flying (t0 + 3)

  • 0.220***

1.021*** 0.988*** (0.032) (0.209) (0.206) Virgin Route - flying (t0 + 4)

  • 0.151***

1.480*** 1.457*** (0.030) (0.203) (0.197) Virgin Route - flying (t0 + 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 R2 0.792 0.898 0.903 Observations 1329 1329 1329 John Kwoka & Birzhan Batkeyev Strategic Responses to Competitive Threats

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SLIDE 12

United’s Response to Virgin Entry on (EWR-LAX) I

John Kwoka & Birzhan Batkeyev Strategic Responses to Competitive Threats

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SLIDE 13

United’s Response to Virgin Entry on (EWR-LAX) II

ln(Price) ln(Departures) ln(Seats) Virgin Route - not flying (t0 − 6)

  • 0.137***

0.146 0.153 (0.028) (0.190) (0.183) Virgin Route - not flying (t0 − 5)

  • 0.210***

0.079 0.069 (0.024) (0.168) (0.163) Virgin Route - not flying (t0 − 4)

  • 0.117***

0.522*** 0.523*** (0.023) (0.170) (0.169) Virgin Route - not flying (t0 − 3) 0.059** 0.623*** 0.557*** (0.025) (0.206) (0.201) Virgin Route - not flying (t0 − 2) 0.013 0.451** 0.350** (0.024) (0.178) (0.170) Virgin Route - not flying (t0 − 1) 0.046* 0.491** 0.455** (0.027) (0.214) (0.214) Virgin Route - entered (t0)

  • 0.162***

0.771*** 0.711*** (0.025) (0.158) (0.153) Virgin Route - flying (t0 + 1)

  • 0.180***

1.242*** 1.155*** (0.029) (0.221) (0.211) Virgin Route - flying (t0 + 2)

  • 0.213***

1.250*** 1.175*** (0.030) (0.193) (0.187) Virgin Route - flying (t0 + 3)

  • 0.247***

0.950*** 0.874*** (0.026) (0.209) (0.205) Virgin Route - flying (t0 + 4)

  • 0.155***

1.309*** 1.247*** (0.022) (0.194) (0.188) Virgin Route - flying (t0 + 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 R2 0.792 0.897 0.903 Observations 1329 1329 1329 John Kwoka & Birzhan Batkeyev Strategic Responses to Competitive Threats

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SLIDE 14

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

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SLIDE 15

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

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SLIDE 16

United on EWR-ORD to Southwest Entry to EWR-MDW

ln(Price) ln(Departures) ln(Seats) Southwest Route - not flying (t0 − 6)

  • 0.139***
  • 0.097
  • 0.089

(0.018) (0.154) (0.149) Southwest Route - not flying (t0 − 5)

  • 0.147***

0.068 0.014 (0.023) (0.162) (0.157) Southwest Route - not flying (t0 − 4)

  • 0.056***
  • 0.364**
  • 0.437***

(0.022) (0.167) (0.159) Southwest Route - not flying (t0 − 3) 0.071**

  • 0.163
  • 0.191

(0.029) (0.181) (0.182) Southwest Route - not flying (t0 − 2) 0.018 0.106 0.086 (0.025) (0.157) (0.156) Southwest Route - not flying (t0 − 1) 0.023 0.038

  • 0.008

(0.022) (0.144) (0.136) Southwest Route - entry (t0) 0.014 0.079 0.070 (0.029) (0.147) (0.141) Southwest Route - flying (t0 + 1)

  • 0.118***
  • 0.112
  • 0.078

(0.021) (0.156) (0.152) Southwest Route - flying (t0 + 2)

  • 0.094***

0.010

  • 0.044

(0.022) (0.177) (0.171) Southwest Route - flying (t0 + 3)

  • 0.146***
  • 0.175
  • 0.224

(0.029) (0.172) (0.164) Southwest Route - flying (t0 + 4)

  • 0.035
  • 0.267**
  • 0.248*

(0.024) (0.131) (0.127) Southwest Route - flying (t0 + 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 R2 0.791 0.897 0.902 Observations 1329 1329 1329 John Kwoka & Birzhan Batkeyev Strategic Responses to Competitive Threats

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SLIDE 17

United on EWR-IAH to Southwest Entry to EWR-HOU

ln(Price) ln(Departures) ln(Seats) Southwest Route - not flying (t0 − 6) 0.059** 0.382** 0.412** (0.026) (0.172) (0.168) Southwest Route - not flying (t0 − 5) 0.146*** 0.228 0.212 (0.022) (0.165) (0.156) Southwest Route - not flying (t0 − 4) 0.128*** 0.441*** 0.522*** (0.021) (0.171) (0.170) Southwest Route - not flying (t0 − 3) 0.192*** 0.375** 0.436*** (0.022) (0.156) (0.153) Southwest Route - not flying (t0 − 2)

  • 0.022

0.480*** 0.539*** (0.025) (0.164) (0.156) Southwest Route - not flying (t0 − 1) 0.094*** 0.334** 0.428*** (0.027) (0.170) (0.164) Southwest Route - entry (t0) 0.012 0.097 0.200 (0.024) (0.169) (0.166) Southwest Route - flying (t0 + 1)

  • 0.038

0.235 0.333* (0.023) (0.189) (0.186) Southwest Route - flying (t0 + 2)

  • 0.071**

0.231 0.304* (0.032) (0.181) (0.175) Southwest Route - flying (t0 + 3) 0.008 0.072 0.075 (0.022) (0.153) (0.147) Southwest Route - flying (t0 + 4)

  • 0.103***

0.256* 0.312** (0.017) (0.143) (0.143) Southwest Route - flying (t0 + 5)

  • 0.061***

0.281** 0.283** (0.017) (0.136) (0.134) Carrier-Route FE Yes Yes Yes Carrier-Quarter FE Yes Yes Yes Year-Quarter FE Yes Yes Yes R2 0.791 0.897 0.902 Observations 1329 1329 1329 John Kwoka & Birzhan Batkeyev Strategic Responses to Competitive Threats

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SLIDE 18

Implications

United lowered price a bit at its hub

No indication of capacity change

Difference in United response likely due to Southwest entry at airports adjacent to United’s own

Viewed as distinct from hubs Less threatening, less need to defend by attacking entrant Price fell due to expanded capacity?

To blunt Southwest’s success To signal not to expand?

John Kwoka & Birzhan Batkeyev Strategic Responses to Competitive Threats

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SLIDE 19

United Response to Southwest Entry on (EWR-STL) I

John Kwoka & Birzhan Batkeyev Strategic Responses to Competitive Threats

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SLIDE 20

United Response to Southwest Entry on (EWR-STL) II

ln(Price) ln(Departures) ln(Seats) Southwest Route - not flying (t0 − 6) 0.000 0.000 0.000 (.) (.) (.) Southwest Route - not flying (t0 − 5)

  • 0.004

0.110 0.153 (0.026) (0.176) (0.172) Southwest Route - not flying (t0 − 4) 0.000 0.000 0.000 (.) (.) (.) Southwest Route - not flying (t0 − 3) 0.000 0.000 0.000 (.) (.) (.) Southwest Route - not flying (t0 − 2) 0.017 0.765** 0.846*** (0.082) (0.321) (0.316) Southwest Route - not flying (t0 − 1) 0.000 0.000 0.000 (.) (.) (.) Southwest Route - entry (t0)

  • 0.004

0.376 0.387 (0.085) (0.321) (0.316) Southwest Route - flying (t0 + 1)

  • 0.221***

4.265*** 3.905*** (0.038) (0.148) (0.147) Southwest Route - flying (t0 + 2)

  • 0.284***

4.354*** 4.061*** (0.035) (0.210) (0.203) Southwest Route - flying (t0 + 3)

  • 0.048

4.097*** 3.717*** (0.030) (0.160) (0.156) Southwest Route - flying (t0 + 4) 0.000 0.000 0.000 (.) (.) (.) Southwest Route - flying (t0 + 5)

  • 0.143***
  • 0.383**
  • 0.365*

(0.031) (0.188) (0.187) Carrier-Route FE Yes Yes Yes Carrier-Quarter FE Yes Yes Yes Year-Quarter FE Yes Yes Yes R2 0.791 0.901 0.906 Observations 1329 1329 1329 John Kwoka & Birzhan Batkeyev Strategic Responses to Competitive Threats

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SLIDE 21

Implications

“Defense” of route not even served Possible explanations

Establish reputation for toughness Defend Newark from successful entry

Much like American’s response to entry by into DFW

SunJet opened to Long Beach in 1994 American did not serve, but launched competing service After SunJet withdrew, American ceased service

John Kwoka & Birzhan Batkeyev Strategic Responses to Competitive Threats

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SLIDE 22

Conclusions and Questions

United’s responses to entry clear

Responds forcefully where threat is direct Lesser response where threat indirect Responds even where there is no threat

Curious aspects

Use of capacity as strategy tool Costly responses Not successful in driving rivals out

Difficult to test motivation directly Difficult to reconcile with accepted theories

John Kwoka & Birzhan Batkeyev Strategic Responses to Competitive Threats