Demand Side: Customer Acquisition

Another type of activities that alliance members are generally involved in is related to customer acquisition: 1) alliances provide better services by offering more options, smoother connections and shared alliance lounges; and 2) alliances allow consumers to accumulate and redeem miles on partners’ flights through their reciprocal frequent flier programs (though certain restrictions may apply). These improvements in service quality may increase customers’ willingness to pay, or induce more high-value customers to purchase. That is, alliances may lead to higher prices for reasons other than mutual forbearance, and these higher margins may provide incentives for airlines to increase capacity. Based on this logic, we examine the following arguments on the demand side.

Alternative Explanation 3: More flight options and higher frequencies are associ- ated with better service quality. The potential of charging higher prices for better services induces airlines to add additional flights in the markets operated with their partners.

While this explanation is consistent with our observations regarding both capacity expansion and price increases, we examine whether the observed price premium can

be explained away through these potential changes in service quality. Effects of more frequent flights might be two-fold: first, by operating additional flights in the markets, airlines are able to charge higher prices due to the improvement of their own services; second, by cooperating with their alliance partners, they may be able to charge higher prices for their partners’ services as well, since consumers can earn and use flying miles with any airline of the same alliance. We examine the contribution of both mechanisms to the price premium, and the results from the fixed effects models are shown in Table 2.8. Column 2 shows that airlines are indeed able to charge higher prices for more frequent services that they provide: the effect of the number of departures (a proxy of service frequency) is significantly positive, while controlling for the total number of seats supplied. However, this does not diminish the price premium charged in markets shared with partners. Meanwhile, Column 3 presents no evidence that airlines are charging additional premium for services provided by their partners: the price premium is still as high as $13.0. Based on these results, we conclude that the quality argument does not explain away our findings regarding price premium. That is, even after controlling for the potential changes in service quality, partners still benefit from the additional pricing power developed from the multimarket contact.

Alternative Explanation 4: After an alliance is formed, partners experience higher demand flowing through their networks, which leads airlines to increase network overlap, expand capacities, and charge higher prices.

fic volumes using the difference-in-difference framework. The results from fixed effects models are shown in Table 2.9. Contrary to the prediction of higher demand, we do not observe any significant increase in traffic volume in markets with partners. Recall that we documented a capacity increase of 420 seats per week. Nevertheless, there is no sizable increase in traffic (i.e., a statistically insignificant increase of 50 passengers per week). Conversely, in the markets in which competitors are present, traffic decreases by 260 passengers per week after capacity is reduced by 320 seats per week. Although the difference-in-difference term is significantly positive, note that we do not observe first-hand evidence of increasing demand in markets operated with partners. The sig- nificant difference-in-difference term can be explained by shrinking capacity in markets with competitors: a reduction of 320 seats per week corresponds to a decrease of 250 passengers per week at the average level of load-factor, i.e., 0.78. One may still suspect that potential increases in demand might have been offset by increases in prices. How- ever, if we hypothesize that increasing demand is the driving force, it is unlikely that prices will offset all changes in demand, as demand changes are the first order effect. Summarizing these two points, we conclude that the demand argument does not provide a plausible explanation to our findings.

Alternative Explanation 5: After an alliance is formed, the composition of de- mand changes. In markets jointly operated with partners, airlines attract more high-value customers with better services, which allows them to charge higher average prices.

DB1B fare data provides some limited information on fareclasses: restricted fare or unrestricted fare (i.e., full fare). We obtain the percentage of passengers traveling on full fares and adopt the difference-in-difference framework to examine how this percentage is affected by alliances. The results from the fixed effects model are presented in Table 2.9, Column 3. The difference-in-difference term is insignificant and negative, providing no support to the presumption that there is an increase in the proportion of high- value customers. We conclude that there is no evidence to support changes in demand composition.

To summarize, we examined five most plausible alternative explanations of our results based on both supply and demand effects of alliances. However, none of them provides compelling explanations to our findings.