Airline Hubs: Costs, Markups and the Implications of Customer Heterogeneity

This paper estimates a model of airline competition that captures the two major features of the industry: product differentiation and economies of density. The results not only provide support to some of the traditional common wisdom in the industry, but are also useful for understanding major puzzles concerning the evolution of the industry. The estimates indicate that a hubbing airline's ability to raise prices is focused on tickets that appeal to price-inelastic business travelers, who favor the origin-hub airline, even while paying an average premium of 20%. These high prices do not, however, provide a `monopoly umbrella' to other non-hub airlines. Finally, on the cost side there is evidence of economies of density (and therefore cost economies of hubbing) on longer routes. Consistent with the `Southwest Airlines' effect, there is no evidence of economies of density on shorter routes.