Airlines Pricing Strategies in Captive Markets: Which Factors Really Matter?



Airlines Pricing Strategies in Captive Markets: Which Factors Really Matter?

Authors

A S Bergantino, C Capozza, Universita degli Studi di Bari "Aldo Moro", IT

Description

We study the Southern Italian market to test the market concentration's impact on fares and if it fosters or not the intertemporal price discrimination application. We assess how modal and intermodal competition effect the accessibility.

Abstract

This paper investigates which factors influence airlines' decisions when planning pricing strategies in captive markets. The Southern Italian market, we first explore, shows a more captive demand compared to the markets analyzed in previous contributions. For peripherical areas air transport is often the only realistic alternative, thus the impact of airline pricing strategies goes beyond the boundaries of the market, easing or hindering the accessibility of the territory.

Our study considers both classic elements of the airline market analysis than distinctive features of the captive market under investigation. We measure the impact of market structure on fares and we focus on the intertemporal price discrimination (IPD), that is to apply different fares to different travellers according to the days missing to departure when the ticket is bought. We portray the characteristics of the IPD implemented in the Southern Italian market and we determine if airlines are more keen to undertake it when competition increases or reduces.

Moreover we assess the effect of airline pricing on accessibility by evaluating the impact of modal and intermodal competition on fares. The modal competition is captured by the merger between the major players in the market and by the presence of low cost competitors; the intermodal competition is captured by the Island-specific pricing strategies.

Data on posted fares are collected to replicate the real travellers' behaviour when making reservations for business or leisure trips. Firstly we identify plausible round trips, afterward we use airline companies' websites to simulate reservations. We observe fares daily starting, generally, sixty booking days before the departure: we define a dataset composed by 20175 observations on 440 round-trips from November 2006 to February 2011 on 15 city-pairs and 12 airline companies. Both Full Service Carriers (FSCs) and Low Cost Carriers (LCCs) are considered, thus we choose the basic services to make effectively comparable carriers' supply. The employment of round trip fares instead of one way fares allows to accurately identified carriers' supply: given the city-pair, a carrier is counted among the competitors if it provides flights for the selected departure and return dates. Additionally, round-trips enable to account precisely for peak-periods to verify if airlines adjust their pricing when the travel demand increases.

We realize a panel analysis where the cross-section is defined by flights described by the route, the carrier, the departure and return dates; the time series is defined by the number of times we observe the fares, thus it goes from 1 to 60. Given that the market structure does not change within time, we need to employ the Random Effects estimator.

Our findings claim that the market power arising from more concentrated markets allows airlines to set higher fares. Airlines undertake the IPD strategies: fares distribution follows a J-curve to exploit the different travellers willingness to pay. Firstly airlines set the initial level of fares that decrease as more price sensitive travellers begin to shop until reaching the minimum; afterward fares steadily increase as the departure date approaches.

The empirical evidence is in favour of "competitive discrimination": a more competitive market structure fosters the implementation of IPD strategies. However airlines strategies differ depending on whether a low cost or a traditional carrier and whether a flight takes place during holidays. Actually LCCs adopt a more aggressive pricing behavior: on average they set lower fares and undertake stronger IPD strategies. Moreover during holidays airlines lessen the IPD because, due to the greater demand, they can fill the plane even without offering early-discounted fares.

One might argue that price discrimination is only beneficial for airlines. Nevertheless in more competitive markets airlines charge lower fares that, together with the IPD, allow to target larger segments of demand which leads to a "democratisation" of air travel.

Some interesting cues of reflection come up when we face the question of accessibility. We find evidence that airlines exploits their dominant position if the modal competition is soften, as in the case of mergers, and if they offer services less accessible areas: the lack of alternative transport services strengthens airlines power, thus limiting the accessibility of the territory. Instead the presence of low cost competitors exerts a downward pressure on traditional carriers fares, thus being beneficial for accessibility.
Developments for future research could be the enlargement of the territorial coverage in order to compare different exogenously determined accessibility conditions; furthermore, we aim to take account of the local governments? subsidies, often granted to airlines, to evaluate their impact on fares and pricing strategies and, thus, on the net welfare of the interested area.

Publisher

Association for European Transport