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Recap of Webinar “The Price Effect of Airline Common Subcontracting”

Yunhao Cai

Recap of Webinar “The Price Effect of Airline Common Subcontracting”
Hinterhaus Productions via Getty Images

On July 28, 2023, the ABA Economics Committee, Transportation and Energy Industries Committee, Pricing Conduct Committee, and Cartel and Criminal Practices Committee co-hosted a webinar on the topic “The Price Effect of Airline Common Subcontracting,” presented by Professor Gaurab Aryal from Washington University in St. Louis. The webinar was moderated by Dr. Yajing Jiang from Charles Rivers Associates and Professor Jan Brueckner from University of California, Irvine provided comments.

In his research, Professor Aryal and his co-authors studied the effect of “common subcontracting” of national (major) airlines with regional carriers on air ticket prices. In recent years, there has been an increasing trend in subcontracting regional airlines (e.g., SkyWest Airlines) by major airlines (e.g., American Airlines) to transport passengers. Because the operating costs for regional airlines are typically lower compared to those for major airlines, such cost savings are likely to be passed on to passengers and result in lower air ticket prices. On the other hand, multiple major airlines that subcontract with the same regional airline (“common subcontracting”) may inform them of others’ costs, which potentially facilitates collusion and leads to higher prices. It is unclear which of these two countervailing forces dominates the other.

Previous research has found that “multimarket contact” in the airline industry, defined as situations where airlines are present and therefore compete with each other in different markets (i.e., one-way routes between two airports), tends to reduce competition and leads to higher prices. On top of this, Professor Aryal’s research aims to focus on common subcontracting by controlling for the multimarket contact, and at the same time, constructing a new measure of overlapping vertical relationships across major airlines.

To empirically estimate the effect of common subcontracting on ticket prices, Professor Aryal and his co-authors use the U.S. Department of Transportation Airline Origin and Destination Survey (DB1B) data, supplemented by data from OAG (a private data vendor that specializes in the airline industry), company 10-K filings, and NOAA weather data with a sample period from 1998 to 2016. Their regression analysis finds that the use of regional airlines by major airlines lowers ticket prices and is consistent with previous literature in showing that multimarket contact increases prices.

The results also show that common use of regional airlines increases ticket prices, and moreover, that such price effect has become stronger in recent years: before 2004, the price effects of moving from a market at the 25th percentile of common subcontracting to one at the 75th percentile was minimal (.06%). However, from 2004 through 2012, the authors observe a price increase of 1.72% if common subcontracting is increased by the same interquartile range (IQR) from 25th percentile to 75th percentile, and in the post 2012 period, the estimated price increase is 5.07%.

An open question is the mechanism that drives this correlation. Professor Aryal noted that an educated conjecture is that common subcontracting could potentially soften competition by informing major airlines of each other’s costs, and thus facilitate collusion. This is because for regional airlines, the cost of employing crews and flying aircrafts are similar when serving different major airlines across different markets. As a result, a major airline could infer the costs of its competitor if they both contract with the same regional airline.

Previous literature (e.g., Awaya and Krishna (2016) and Aryal, Ciliberto and Leyden (2022)) also suggested that information and communication could facilitate collusion, such as in the use of a common ad agency (Bernheim and Whinston (1985)) and common membership in trade associations (Awaya and Krishna (2020)). However, the exact mechanisms and welfare implications of these vertical relationships still need to be further explored.

Following Professor Aryal’s presentation, Professor Brueckner shared his thoughts on this research paper. He noted that Professor Aryal’s research differed from previous work in that previous work only explored the incentives for subcontracting, while this paper empirically examines the price effects from common subcontracting, as well as those from multimarket contact. Professor Brueckner further pointed out that the logic behind the Professor Aryal and his co-authors’ hypothesis may need further explanation: major airlines do not necessarily need common subcontracting to learn about the regional carrier component of their competitors’ costs, as such information could be easily extrapolated through their own partnership with regional airlines. In addition, Professor Brueckner noted that one could argue that higher common subcontracting would lead to co-movement of fares among major airlines since they share similar cost components by using the same regional airline.

Finally, Professor Brueckner suggested that the authors could further investigate whether the fare effect from common subcontracting depends on the contract type (i.e., revenue sharing or fixed-fee). He also noted that regional airlines may have a higher cost per seat-mile due to operating less efficient aircraft, in contrast to what is claimed in the paper. Overall, Professor Aryal and his co-authors’ work has found a new regularity in airline pricing. While the exact mechanism of how common subcontracting leads to higher airfares remain unclear, Professor Brueckner believed that this paper would spark and generate further research on this topic.

This article was prepared by the Antitrust Law Section's Economics Committee.