Network effects and incumbent response to entry threats: empirical evidence from the airline industry

TL;DR

This paper examines how U.S. airline incumbents respond strategically to entry threats by Southwest Airlines, revealing preemptive capacity increases and complex fare adjustments influenced by network structure.

Contribution

It provides new empirical evidence on incumbents' strategic responses to entry threats, highlighting the shift from price to capacity adjustments and the role of network structure.

Findings

Incumbents cut fares by 6-8% post-entry.

Capacity increases by 10-40% pre-entry and 27-46% post-entry.

Post-entry capacity response depends on network centrality.

Abstract

I investigate how incumbents in the U.S. airline industry respond to threatened and actual route entry by Southwest Airlines. I use a two-way fixed effects and event study approach, and the latest available data from 1999-2022, to identify a firm's price and quantity response. I find evidence that incumbents cut fares preemptively (post-entry) by 6-8% (16-18%) although the significance, pattern, and timing of the preemptive cuts are quite different to Goolsbee and Syverson's (2008) earlier results. Incumbents increase capacity preemptively by 10-40%, up to six quarters before the entry threat is established, and by 27-46% post-entry. My results suggest a clear shift in firms' strategic response from price to quantity. I also investigate the impact of an incumbent's network structure on its preemptive and post-entry behaviour. While the results on price are unclear, a firm's post-entry capacity reaction depends strongly on its global network structure as well as the local importance (centrality) of the route.