Does Multipoint Competition amongst European Airlines Lead to a Reduction of Competitive Pressure?

Mouyrin RenaudPh.D. Student

CEROG IAE Aix en Provence

Financed and Supported by Eurocontrol Experimental Center

Strategy Unit

Agenda

• Theoretical Background

• Purpose of the study

• The Research Model & Hypotheses

• Methodology– Data

– Measures

• Preliminary results provided by an alternative model

• Next steps

Theoretical background: What is Multipoint Competition?

• Situation in which firms meet simultaneously the same rivals in more than one market

• As each City Pair connection can be considered as discrete market…

• …airlines probably have multimarket contacts with competitors

• One major element of the competitive interaction between 2 airlines that may influence their competitive behavior towards each other.

Theoretical background: The Mutual Forbearance Hypothesis

• Theory: Familiarity

Multimarket Competitive

Contacts Intensity

Deterrence• Multiple contacts give the option to respond to an attack

by a rival not only in the challenged market• Airlines Competitive moves are linked across markets• Specter of retaliation reduces the motivation to act

aggressively

Example in the US airlines industry (1989)

• AW entered in H. with low introductory fares.

• CA responded by lowering prices from P.

• AW stopped immediately its low fares in H.

• AW and CA entered into a code share agreement

Phoenix Houston

America’s West hub Continental Airline’s hub

Theoretical background: Past Researches

• Empirical studies in the US airline Industry• Multimarket contacts lead to higher averages fares

(Evans and Kessides, 1994; Gimeno, 1999)• Multimarket contacts in rival’s strategic markets (High

Market share, High Market dependence, City Pair connectivity in the airline

network) are more effective than contacts in rival’s secondary markets. (Gimeno, 1999)

• Airline’s Market Entry in and Market Exit from rivals markets is unlikely when the 2 airlines are strong multipoint competitors (respectively to avoid competitive escalation and to maintain a deterrence mechanism) (Baum and Korn, 1996 and 1999)

Purpose of he study: Why testing Mutual Forbearance Hypothesis in the European Airlines Industry?

• Data source geographical transposition, from the US airlines industry to the European One.

• We have not yet reviewed an empirical study on the Multipoint Competition effects on the European industry

• Is the competitive and the institutional frameworks of the European industry is adapted for airlines to achieve Mutual Forbearance Strategy?

• Understand and highlight one potential source of European airlines industry competitive distortion.

The Model Research

Multipoint Competition

Airline competitive commitment change in rival’s territories

Airline exit from rival’s territories

Airline Entry in rival’s territories

Multimarket Contacts

Airlines competitive Interactions.

Competitive Moves.

?

Period t

Period t+1

Multimarket Contacts and the dynamics of competitive interactions

- Decreased aggressiveness that follows recognition of mutual dependence and

potential for multimarket retaliation

- Recognition of mutual dependence and potential for multimarket retaliation

Suppressed bySuppressed byHIGH

- Incentive to establish a foothold to signal ability to counterattack

- Aggressive interactions among airlines that meet in one or only a few market routes

- Aggressive interactions among airlines that meet in one or only a few routes

Stimulated byStimulated byLOW

Market exit rate / decrease in flight frequency and seat capacity

Market entry rate / increase in flight frequency and seat capacity

Multimarket contact

Effects of multimarket contacts on rates of market entry and exit and change in flight frequency (Baum and Korn, 1999)

Multimarket Contacts and the dynamics of competitive interactions

Likelihood of Market entry in and exit from rival’s territories

Multimarket contacts0

Hypothesis

• H1: A firm’s rate of entry into a competitor’s markets is related in an inverted manner to the level of multimarket contacts with the competitor.

• H2: A firm’s rate of exit from a competitor’s markets is related in an inverted manner to the level of multimarket contacts with the competitor.

• H3: The likelihood of a firm competitive commitment change into a competitor’s markets is related in an inverted manner to the level of multimarket contacts with the competitor.

Methodology: Data and sample description

• Longitudinal and cross-market study. OAG data Base from 2002 to 2006.

• Scheduled, Regular and Direct flight within the European Union (25) + Norway and Switzerland: Homogeneous Institutional framework

• 3963 City Pair (markets); 119 carriers; 10506 unique Competitor-dyad/year (pairs of airlines by year)

Methodology: Measure of Independent variables

• Multimarket contactsijt between 2 airlines=

Sum Mit [Cimt x (Dimt x Djmt)]+ Sum Mjt[Cjmt x (Dimt x Djmt)] Mit + Mjt

Sets of Markets

served by firms i and j

at time t

Centrality of the route m to the route networks of airlines i and j at time t

(airlines routes’ strategic importance)

Indicator variables set equal to 1 if airlines i

and j are active in route m at time t and

0 otherwise

Examples

0.021234.04285Air France38.44232IberiaW2002

0.021238.44232Iberia34.04285Air FranceW2002

0.111239.72150Alitalia100.0012Volare AirlinesW2002

0.1112100.0012Volare Airlines39.72150AlitaliaW2002

0.171298.11106KLM85.7120Transavia AirlinesW2002

0.171285.7120Transavia Airlines98.11106KLMW2002

0.321680.2124Blue198.5760FinnairW2002

0.321698.5760Finnair80.2124Blue1W2002

0.441874.0724Aegean Airlines44.4435Olympic AirlinesW2002

0.441844.4435Olympic Airlines74.0724Aegean AirlinesW2002

Weighted multipoin

t contacts

Net Multipoint Contacts

Average Airline j'scentrality of routes

in contacts with i

Airlinej

set of markets

Airline j

Average Airline i's

centrality of routes

in contacts with j

Airline i set of

MarketsAirline i

PERIOD

Reliability Statistics

.717 3

Cronbach'sAlpha N of Items

Measures: Dependant variables

• Airline i Entry in rival’s j markets

– The seasonally number of entry by airline i into each of its j competitor’s route

• Airline i Exit from rival’s j markets

– The seasonally number of exit by airline i from each of its j competitor’s route

• Airline i change in competitive commitment in rival’s j markets– Average Airline i Change in flight frequency

– Average Airline i Change in seat capacity in each of its j competitor’s route

– Average Airline i Change in market share

• Data Reduction Process through Principal Component Analysis

Factorial Score Computation for each observation

Other Control Variables

• Relative size (size j / size i)

• Age of Airline i and j

• Airline i’s route dominance over competitor j

• Airline i’s entries into competitor j’s route (previous year)

• Airline i’s average capacity (seats) route

• Airline i’s average route density (number of competitors)

Preliminary Results

• Not yet achieved empirical test of the research model presented.

• Previous Model based on a market unit analysis (Airline route) not at firm level (interaction between airlines), provided exploratory and complementary results.

15.48Airlines Maintaining in markets

10.86Airlines Exiting Markets

11.78Airlines Entering new markets

15.13All Airlines

Average Multimarket Contacts with each City Pair Competitors

Variable Selection

Preliminary results: Entry Rate and Multimarket Contacts

100,00

80,00

60,00

40,00

20,00

0,00

Entry

_rate

Correlations

1 -.239**

.000

1437 1437

-.239** 1

.000

1437 1437

Pearson Correlation

Sig. (2-tailed)

N

Pearson Correlation

Sig. (2-tailed)

N

Entry rate

Multimarketcontact

EntryRate

multimarket contact

Correlation is significant at the 0.01 level (2-tailed).**.

Preliminary results: Airlines’ competitive commitment variance decreases while MC increase.

2,50000

0,00000

-2,50000Airlin

es_c

hang

e_co

mp_c

ommi

tmen

t

Multimarket contacts

Preliminary results conclusions

• The choice of markets to enter in and to exit from is partly determined by the level of multimarket contacts an airline has with its competitors.

• The magnitude of airline’s changes in flight frequency, seats capacity and in market share, is also determined by multimarket contacts it has with its competitors.

• Stability of an airline competitive behavior is more likely when it has a high level of multimarket contacts with its competitors

Next Steps

• The preliminary analysis allows us to pursue investigations on European Airlines Mutual Forbearance Strategies but not to (in)validate hypotheses.

• As Multipoint Competition is a property of the relationship between two airlines…

• …we need to determine a fully model, integrating all competitor-dyadic level observations (with control variables), to be statistically tested through Poisson and Binomial regression analysis, which is actually running…