How Airlines Compete
William M. Swan
July 2002

Abstract

Airlines compete in city-pair markets. Each airline in the market plans a schedule of departure times and offers a series of fares. The minimum level of complication must deal with both time-of-day and at least two types of fares. Where customers find both needs met by both airlines, they choose based on secondary characteristics of the competitors, which we call quality. This simple model of the demand side leads to some compelling consequences on the supply side. The discussion below starts with one time of day; two types of fares, business and leisure; and a primitive expression of capacity limits and revenue management. Discussion then adds several levels of realism to that foundation. We find a preferred airline dominates strongly in both average fare and load factor. Also a preferred airline does best by matching fares, rather than getting a surcharge for its quality. It is suggested that if the competing airline can find a non-competitive time of day it might survive on lower costs, but the temptation will be strong to seek its own different markets. The primary lesson about airline competition is that airlines have strong incentives to match. A preferred airline does best matching prices, while a non-preferred airline does poorly unless it can match preference

Introduction

Airlines compete in city-pair markets. Each airline in the market plans a schedule of departure times and offers a series of fares. The fundamentals of airlines competing are this: customers choose based on price and time, and those customers who find both airlines equal choose based on secondary characteristics we call quality. This simple model of the demand side leads to some compelling consequences on the supply side. The discussion below starts with the simplest possible model, and then