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airports with Federal Aviation Administration (FAA) imposed capacity limits
(Chicago's O'Hare, Washington's National, New York's LaGuardia, and Atlanta's Hartsfield) can slots be bought and
sold. Entering airlines would find these
resources much easier to acquire under
a market or auction system.
In summary, the control of scarce airport resources that are vital to the success of any market entry (the gates and
takeoff and landing slots) have been
acquired by the incumbent airlines and,
in particular, by the hub airline. This
control enables the incumbent airlines
to erect entry barriers, which make
entry more difficult for its potential
rivals. Barriers inhibit effective competition and enable the hub airline to use
its increased market power to charge
higher fares to the "to" passengers.
Conclusion and Policy
Recommendations
The relationship between competition,
concentration, and fares in the airline
industry has been considered in light of
the increased use of hub-and-spoke
networks. "Through" passengers generally have more options and lower
fares than "to" passengers. Fares to

5. See "Growing Giants: An Unexpected Result
of Airline Decontrol Is Return to Monopolies,"
The Wall Street Journal, July 20,1987, p. 1.

Federal Reserve Bank of Cleveland
Research Department
P.O. Box 6387
Cleveland, OH 44101

Material may be reprinted provided that the
source is credited. Please send copies of reprinted
materials to the editor.

and from airports with only one hub
airline appear to be higher than the
competitive level, largely as a result of
entry barriers, although passengers in
these markets are compensated somewhat by the better service on these
routes (more flights overall, as well as
more nonstop flights). Though few analysts have advocated returning to CABtype economic regulation, some have
questioned whether some type of action
might be needed. If action is to be
taken, it should be in accord with the
specificity principle: attack the problem
at its source.
In line with this precept, public policy should move toward lowering entry
barriers. First, control of gate space
and future airport expansion must rest
more firmly in the control of airport
managers and less in the hands of the
incumbent airlines. Specifically, longterm leases should be avoided, and airlines that fail to utilize their gate space
should lose it."
Second, takeoff and landing slots
should follow competitively determined
peak load pricing at all airports. By
charging higher takeoff and landing

fees at the busiest times, peak load
pricing would alloca te airport resources
more fairly and would lower the entry
barriers that have developed under the
present system. An important additional benefit would be increased air
safety and fewer traffic delays. Airport
facilities would be more uniformly utilized over the course of the day (since
fare-sensitive tourist passengers would
switch to less costly off-peak flights),
helping to smooth out the peak demands
on the air traffic control system.
Moving in these two directions would
significantly lower the barriers that
currently exist for airlines that wish to
enter or expand their operations at the
hubs of their rivals. In turn, these
actions would lessen the ability of the
hub airline to charge higher fares to
passengers whose origin or destination
is a hub. Though it appears unlikely,
even with these recommended changes
in policy, that the promise of fully
competitive markets will ever be met
exactly in the airline industry, airline
deregulation has yielded significant
economic benefits to travelers, and
pursuing these policies should preserve
and extend the benefits.

6. Efforts of some airlines to increase service to
Cleveland have been forestalled by United's
reluctance to free up gate space it no longer
requires.

BULK RATE
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Cleveland,OH
Permit No. 385

Address Correction Requested: Please send
corrected mailing label to the Federal Reserve
Bank of Cleveland, Research Department,
P.O. Box 6387, Cleveland, OH 44101.

September 15, 1987

Federal Reserve Bank of Cleveland

ISSN 0428·]276

ECONOMIC
COMMENTARY
The current performance of the U.S.
airline industry with regard to safety,
fares, and service has been a topic of
widespread concern among policymakers and the public. One aspect of this
concern is the relationship between
competition, concentration, and air
fares. Competition is required to
achieve and preserve the full benefits of
deregulation, particularly if fares are to
be set as low as possible.
Traditional economic theory predicts
that increases in concentration (as
measured by the market shares of the
largest firms in the industry) lead to
increases in market power (the ability
of firms to charge a price higher than
would prevail in a competitive market).
As a result of a wave of mergers in the
airline industry over the last year,
these measures of concentration have
risen significantly, leading to a great
deal of discussion about the negative
implications for competition and fares.
Unfortunately, much of this discussion
suffers from an inadequate understanding of the nature of the hub-and-spoke
networks that airlines formed after the
Airline Deregulation Act of 1978.
This Economic Commentary seeks to
assess the true state of competition and
concentration in the airline industry.
We first present the current measures
of concentration at both the national
and airport levels. Evidence suggests
that some types of fares are set above
the competitive level. However, the
state of competition is not as bad as the
measures of concentration indicate,
because these measures fail to account
for the effects of hub-and-spoke net-

Paul W. Bauer is an economist at the Federal
Reserve Bank of Cleveland. The author thanks
Mary Deily and Gary Whalen for helpful comments
and Paula Loboda for extensive research assistance.
The views stated herein are those of the author
and not necessarily those of the Federal Reserve
Bank of Cleveland or of the Board of Governors of
the Federal Reserve System.

Table 1 National Market
Shares of the Largest U.S.
Airlines!
Airline

Texas Air
Continental"
Eastern
United
American
Delta3
Northwest'
TWAS
Pan Am
USAir

Market Share

20.1
10.5
9.6
15.7
13.5
11.9
9.4

8.1
5.7
3.0

1. Market shares are based on each carrier's
percent of revenue passenger enplanements
on a national basis.
2. Includes New York Air, People Express,
and part of Frontier Airlines.
3. Includes Western's market share.
4. Includes figures for Republic, which was
formed by the merger of North Central and
Southern.
5. Includes Ozark's market share.
SOURCE: Data derived from "Texas Air's
Hard Bargainer," New York Times, September
16,1986.

works. The efficient operation of huband-spoke systems leads to higher concentration at the airport level, but not
necessarily to higher fares.
We then examine the sources of
market power airlines have as a result
of entry barriers. Any barrier that
makes it difficult for new firms to enter
the market limits competition, leading

1. A widely applied rule of thumb comes from
U.S. Circuit Court Judge Learned Hand: ..... [a
market share over ninety percent] is enough to
constitute a monopoly; it is doubtful whether
sixty ... percent would be enough; and certainly

Competition,
Concentration, and
Fares in the U.S.
Airline Industry
by Paul W. Bauer

to higher fares. Adjustments in the
way airports allocate resources among
airlines would go a long way toward
lowering entry barriers and increasing
competition in markets with less-thancompetitive fares.
Current Levels of Concentration
As a result of a wave of mergers in
1986, the U.S. airline industry went
from domination by 12 carriers to domination by eight carriers. Table 1 presents the current market shares of the
eight largest airlines, based on revenue
passenger enplanements. Texas Air,
which controls both Continental and
Eastern, has become the largest airline,
pushing United and American into
second and third places.
At the national level, concentration
of this magnitude probably should not
cause undue concern.' In addition, all
eight of these airlines have established
or are constructing national route networks, which could very well make the
industry dominated by eight airlines
more competitive than the one dominated by 12. The trend toward mergers,
especially over the last year, bears
watching, however.
At the local level, most individual
airports have concentration levels
higher than the national levels, but still
below the level that would be required
for monopoly pricing. Collusive pricing
in a tight oligopoly always remains a
concern; but airline profits of late have
not been excessive.
Table 2 presents the market shares
of the largest airlines (in all cases airlines with a hub at the airport) serving

thirty-three percent is not," in William Breit and
Kenneth G. Elzinga, The Antitrust Casebook:
Milestones in Economic Regulation, New York:
CBS College Publishing, 1982, p. 117.

Table 2
Airports!

Market

Shares

of the Largest

Airport

Airline

U.S. Airlines

at Selected

Enplanements
1978
1985

Chicago (O'Hare)

United
American

33.1
18.6

41.8
30.3

Atlanta (Hartsfield)

Delta
Eastern

50.1
38.6

52.3
41.5

Dallas-Fort Worth

Braniff
American
Delta

33.7
29.8
16.6

61.1
23.8

Los Angeles
In tern ational

United
WesternAmerican

27.8
16.9
16.4

16.2
14.1
12.6

Denver

United

32.0

FrontierContinental

19.9
19.3
39.4
20.6

35.8
25.4
22.5

St. Louis

TWA
Ozark'

Pittsburgh

Allegheny

Minneapolis

Northwest
North Central"

Houston

Continental

Detroit

American

19.0
21.7

Delta

21.4

46.7
31.7
21.4

57.1
27.2
79.8
42.5
36.7
57.6
60.8
(Repu blic")
13.2
(Northwest)

1. Market shares are based on each carrier's proportion of revenue passenger enplanements at each
airport.
2. Delta has since acquired Western.
3. Frontier has since sold a significant portion of its assets to United; Continental purchased the
remaining assets.
4. TWA has since merged with Ozark.
5. Northwest has since acquired North Central.
6. Republic. which was formed by the combination of North Central and Southern. has since
merged with Northwest.
SOURCE: Federal Aviation Administration.

some selected large airports for 1978
and 1985. The airports are ranked by
traffic: the first four are the largest in
the country, and the second six are
selected large airports with at least one
hub airline. The market shares of the
largest carriers at an airport have
increased since deregulation, particularly at the last six airports. For the
four largest airports, the market shares
of the airlines are larger than their

respective national market shares, but
only American's position in Dallas-Fort
Worth even begins to approach a
monopoly level. At the last five airports, however, the market shares of
the hub airlines are quite high.
Note that the high levels of concentration occur at airports that have only one
hub airline. The largest airports, with
two or more hub carriers, and the smaller airports, with no hub airlines, do not
tend to have the high levels of concen-

2. See Elizabeth E. Bailey, David R. Graham, and
David P. Kaplan, Deregulating the Airlines, Cambridge, MA: The MIT Press, 1985; and Steven
Morrison and Clifford Winston, The Economic
Effects of Airline Deregulation, Washington, D.C.:
Brookings Institution, 1986.

3. See Paul W. Bauer, "Determinants and Effects
of Airline Hubbing," Federal Reserve Bank of
Cleveland Working Paper (forthcoming).

tration found at these intermediate-size
airports. This suggests that the high
levels of concentration observed at
these single-carrier hubs are somehow
connected with the hub activity. The
next section explores this possibility.
Function and Effects of Hub-andSpoke Networks
The switch to hub-and-spoke networks
after deregulation has been the most
important single innovation in the airline industry in the last 10 years.
Before deregulation, airlines served the
routes that the Civil Aeronautics Board
(CAB) allocated to them. The CAB did
not assign these routes solely on the
basis of achieving economic efficiency,
and a patchwork route network evolved
(see figure 1).
The CAB frequently assigned profitable new routes to financially weak carriers in an effort to help shore them up.
Under deregulation, the airlines were
given the freedom to select their own
routes, and most of them moved toward
setting up hub-and-spoke networks,
such as the one depicted in figure 2.
Flights commence at the spoke cities,
where passengers, no matter what
their final destination, board flights for
the hub city. Passengers going to various destinations are on board, so the
load factor (the proportion of the seats
on the plane that are filled) is higher,
and the flights from the spoke to the
hub can depart more frequently. At the
hub city, passengers make connections
to their final destinations. All of the
people going to these various destinations have been collected at the hub, so
the flights from the hub to the spoke
cities have higher load factors and can
leave more frequently.
In order for the hub to be successful,
the flights into and out of the hub must
be coordinated. The incoming flights
must land at about the same time and
must pull into gates that are close
enough together so that passengers can
easily make their connections. The
flights must then depart as quickly as
possible to keep travel times down. This
cycle repeats itself several times throughout the day. Thus, the hub airline must
have access to enough gates and takeoff

4. See Richard V. Butler and John H. Huston,
"Actual Competition, Potential Competition, and
the Impact of Airline Mergers on Fares," Paper
presented at the Western Economic Association
meetings, Vancouver, B.C., July 1987.

and landing slots to handle its traffic,
especially at peak travel times in the
early morning and evening.
The hub-and-spoke networks offer
three advantages to the airlines and to
passengers." First, they enable an airline to offer more frequent service,
resulting in more passengers having
flights closer to their preferred departure times. Second, the travel time for
the average traveler has decreased.
Passengers beginning at a hub will
usually be able to find a nonstop flight,
while those at the spoke cities will
usually have to endure no more than a
one-stop flight. Flights with three or
more intermediate stops, which were
quite common under CAB regulation,
have been eliminated for the most part.
Last, the average load factors (the percentage of seats sold on an average
flight) have increased, lowering the perpassenger costs to the airlines and thus
enabling them to lower fares.
The presence of a hub airline at an
airport more than doubles the airport's
traffic, other things being equal.' Put
another way, more than half of the passengers at the airport will be there only
as a result of the hub activity. Most of
these passengers will be "through"
passengers-travelers
flying from one
spoke city to another by flying through
the hub. "To" passengers, on the other
hand, are travelers who are beginning
or ending their trip at the hub airport.
Thus, much of the increase in concentration is endogenous and driven by the
hub activity, which is the most efficient way of serving the markets.
The implication is that the market
share for an airline at one of its hubs is
a biased measure of its market power.
First, by initiating hub service, the hub
airline increases both its number of
flights and the total number of flights
at the airport. This results in the hub
airline's market share increasing, even
if the other airlines maintain the same
level of service.
Second, if an airline has an 80 percent market share at its hub airport,
and if most of the "through" passengers fly on the hub airline (which is
very likely), then the hub airline will
have close to a 100 percent market
share of the "through" passengers, but

less than a 60 percent market share of
the "to" passengers. This, in turn,
might lead one to expect higher
"through" fares than "to" fares, after
adjusting for any cost differences.
Butler and Huston (1987) found exactly the opposite when they compared the
fares charged on "to" and "through"
routes using St. Louis as a hub.' By comparing the sum of the two legs of the
"to" routes that formed the "through"
routes, they found that fares on "to"
routes were 47 percent to 57 percent
higher than on "through" routes.
This points out an additional problem with using airport market shares
as a measure of market power: the market share for the "through" passengers
has been calculated improperly. These
passengers do not have to fly through a
particular hub and, hence, with a particular airline. For example, in flying
from Cleveland to New Orleans, there
are no nonstop flights. One can fly
TWA through St. Louis, United through
Chicago, Delta through Atlanta, or
Northwest through Memphis. While
anyone of these airlines has a high
market share of the "through" passengers at its respective hub, the correct definition for this market is clearly
broader. Using broader market definitions would reduce the measure of concentration in the "through" markets,
bringing it closer to the national concentration levels.
Given the findings of Butler and
Huston and the various route choices
available to the "through" passengers,
there seems to be little cause for concern about the fares charged to most
"through" passengers. The investigation can now be more narrowly focused
on the sources of market power in the
"to" markets.
Sources of Market Power in
the "To" Markets
The ability of airlines with hubs to
charge higher fares to "to" passengers
than to "through" passengers can be
readily explained by the traditional
industrial-organization notion of entry
barriers. Entry barriers allow incumbent firms to inhibit other firms from entering their markets. The current method of allocating airport resources gives
incumbent airlines, in particular hub
airlines, significant control over entry
into their markets by other airlines.

Figure 1 Typical Route
Network Before Deregulation

Figure 2 Typical
Spoke Network

Hub-and-

The two most important resources
are gate space and takeoff and landing
slots. Airport operators in the past have
worried about financing airport expansions and locking airlines into providing service to the airport. For these
reasons they have been very eager to
sign long-term leases with the airlines,
especially with the hub airlines, which
lease large numbers of gates. With
these long-term leases, airlines can
make it difficult for new carriers to
enter the market or for existing carriers to expand service.
Although an airline that wishes to
commence or expand service may be
able to help finance the construction of
new gates (though often the existing
carrier can forestall even this, as these
expansions generally have to connect
with the main terminal), this path is
both risky and expensive. It creates
fixed capital that may be difficult to
divest if the entry proves unsuccessful."
The allocation of takeoff and landing
slots can also be a source of entry barriers. At most airports, slots are allocated administratively. Only at the four

Table 2
Airports!

Market

Shares

of the Largest

Airport

Airline

U.S. Airlines

at Selected

Enplanements
1978
1985

Chicago (O'Hare)

United
American

33.1
18.6

41.8
30.3

Atlanta (Hartsfield)

Delta
Eastern

50.1
38.6

52.3
41.5

Dallas-Fort Worth

Braniff
American
Delta

33.7
29.8
16.6

61.1
23.8

Los Angeles
In tern ational

United
WesternAmerican

27.8
16.9
16.4

16.2
14.1
12.6

Denver

United

32.0

FrontierContinental

19.9
19.3
39.4
20.6

35.8
25.4
22.5

St. Louis

TWA
Ozark'

Pittsburgh

Allegheny

Minneapolis

Northwest
North Central"

Houston

Continental

Detroit

American

19.0
21.7

Delta

21.4

46.7
31.7
21.4

57.1
27.2
79.8
42.5
36.7
57.6
60.8
(Repu blic")
13.2
(Northwest)

1. Market shares are based on each carrier's proportion of revenue passenger enplanements at each
airport.
2. Delta has since acquired Western.
3. Frontier has since sold a significant portion of its assets to United; Continental purchased the
remaining assets.
4. TWA has since merged with Ozark.
5. Northwest has since acquired North Central.
6. Republic. which was formed by the combination of North Central and Southern. has since
merged with Northwest.
SOURCE: Federal Aviation Administration.

some selected large airports for 1978
and 1985. The airports are ranked by
traffic: the first four are the largest in
the country, and the second six are
selected large airports with at least one
hub airline. The market shares of the
largest carriers at an airport have
increased since deregulation, particularly at the last six airports. For the
four largest airports, the market shares
of the airlines are larger than their

respective national market shares, but
only American's position in Dallas-Fort
Worth even begins to approach a
monopoly level. At the last five airports, however, the market shares of
the hub airlines are quite high.
Note that the high levels of concentration occur at airports that have only one
hub airline. The largest airports, with
two or more hub carriers, and the smaller airports, with no hub airlines, do not
tend to have the high levels of concen-

2. See Elizabeth E. Bailey, David R. Graham, and
David P. Kaplan, Deregulating the Airlines, Cambridge, MA: The MIT Press, 1985; and Steven
Morrison and Clifford Winston, The Economic
Effects of Airline Deregulation, Washington, D.C.:
Brookings Institution, 1986.

3. See Paul W. Bauer, "Determinants and Effects
of Airline Hubbing," Federal Reserve Bank of
Cleveland Working Paper (forthcoming).

tration found at these intermediate-size
airports. This suggests that the high
levels of concentration observed at
these single-carrier hubs are somehow
connected with the hub activity. The
next section explores this possibility.
Function and Effects of Hub-andSpoke Networks
The switch to hub-and-spoke networks
after deregulation has been the most
important single innovation in the airline industry in the last 10 years.
Before deregulation, airlines served the
routes that the Civil Aeronautics Board
(CAB) allocated to them. The CAB did
not assign these routes solely on the
basis of achieving economic efficiency,
and a patchwork route network evolved
(see figure 1).
The CAB frequently assigned profitable new routes to financially weak carriers in an effort to help shore them up.
Under deregulation, the airlines were
given the freedom to select their own
routes, and most of them moved toward
setting up hub-and-spoke networks,
such as the one depicted in figure 2.
Flights commence at the spoke cities,
where passengers, no matter what
their final destination, board flights for
the hub city. Passengers going to various destinations are on board, so the
load factor (the proportion of the seats
on the plane that are filled) is higher,
and the flights from the spoke to the
hub can depart more frequently. At the
hub city, passengers make connections
to their final destinations. All of the
people going to these various destinations have been collected at the hub, so
the flights from the hub to the spoke
cities have higher load factors and can
leave more frequently.
In order for the hub to be successful,
the flights into and out of the hub must
be coordinated. The incoming flights
must land at about the same time and
must pull into gates that are close
enough together so that passengers can
easily make their connections. The
flights must then depart as quickly as
possible to keep travel times down. This
cycle repeats itself several times throughout the day. Thus, the hub airline must
have access to enough gates and takeoff

4. See Richard V. Butler and John H. Huston,
"Actual Competition, Potential Competition, and
the Impact of Airline Mergers on Fares," Paper
presented at the Western Economic Association
meetings, Vancouver, B.C., July 1987.

and landing slots to handle its traffic,
especially at peak travel times in the
early morning and evening.
The hub-and-spoke networks offer
three advantages to the airlines and to
passengers." First, they enable an airline to offer more frequent service,
resulting in more passengers having
flights closer to their preferred departure times. Second, the travel time for
the average traveler has decreased.
Passengers beginning at a hub will
usually be able to find a nonstop flight,
while those at the spoke cities will
usually have to endure no more than a
one-stop flight. Flights with three or
more intermediate stops, which were
quite common under CAB regulation,
have been eliminated for the most part.
Last, the average load factors (the percentage of seats sold on an average
flight) have increased, lowering the perpassenger costs to the airlines and thus
enabling them to lower fares.
The presence of a hub airline at an
airport more than doubles the airport's
traffic, other things being equal.' Put
another way, more than half of the passengers at the airport will be there only
as a result of the hub activity. Most of
these passengers will be "through"
passengers-travelers
flying from one
spoke city to another by flying through
the hub. "To" passengers, on the other
hand, are travelers who are beginning
or ending their trip at the hub airport.
Thus, much of the increase in concentration is endogenous and driven by the
hub activity, which is the most efficient way of serving the markets.
The implication is that the market
share for an airline at one of its hubs is
a biased measure of its market power.
First, by initiating hub service, the hub
airline increases both its number of
flights and the total number of flights
at the airport. This results in the hub
airline's market share increasing, even
if the other airlines maintain the same
level of service.
Second, if an airline has an 80 percent market share at its hub airport,
and if most of the "through" passengers fly on the hub airline (which is
very likely), then the hub airline will
have close to a 100 percent market
share of the "through" passengers, but

less than a 60 percent market share of
the "to" passengers. This, in turn,
might lead one to expect higher
"through" fares than "to" fares, after
adjusting for any cost differences.
Butler and Huston (1987) found exactly the opposite when they compared the
fares charged on "to" and "through"
routes using St. Louis as a hub.' By comparing the sum of the two legs of the
"to" routes that formed the "through"
routes, they found that fares on "to"
routes were 47 percent to 57 percent
higher than on "through" routes.
This points out an additional problem with using airport market shares
as a measure of market power: the market share for the "through" passengers
has been calculated improperly. These
passengers do not have to fly through a
particular hub and, hence, with a particular airline. For example, in flying
from Cleveland to New Orleans, there
are no nonstop flights. One can fly
TWA through St. Louis, United through
Chicago, Delta through Atlanta, or
Northwest through Memphis. While
anyone of these airlines has a high
market share of the "through" passengers at its respective hub, the correct definition for this market is clearly
broader. Using broader market definitions would reduce the measure of concentration in the "through" markets,
bringing it closer to the national concentration levels.
Given the findings of Butler and
Huston and the various route choices
available to the "through" passengers,
there seems to be little cause for concern about the fares charged to most
"through" passengers. The investigation can now be more narrowly focused
on the sources of market power in the
"to" markets.
Sources of Market Power in
the "To" Markets
The ability of airlines with hubs to
charge higher fares to "to" passengers
than to "through" passengers can be
readily explained by the traditional
industrial-organization notion of entry
barriers. Entry barriers allow incumbent firms to inhibit other firms from entering their markets. The current method of allocating airport resources gives
incumbent airlines, in particular hub
airlines, significant control over entry
into their markets by other airlines.

Figure 1 Typical Route
Network Before Deregulation

Figure 2 Typical
Spoke Network

Hub-and-

The two most important resources
are gate space and takeoff and landing
slots. Airport operators in the past have
worried about financing airport expansions and locking airlines into providing service to the airport. For these
reasons they have been very eager to
sign long-term leases with the airlines,
especially with the hub airlines, which
lease large numbers of gates. With
these long-term leases, airlines can
make it difficult for new carriers to
enter the market or for existing carriers to expand service.
Although an airline that wishes to
commence or expand service may be
able to help finance the construction of
new gates (though often the existing
carrier can forestall even this, as these
expansions generally have to connect
with the main terminal), this path is
both risky and expensive. It creates
fixed capital that may be difficult to
divest if the entry proves unsuccessful."
The allocation of takeoff and landing
slots can also be a source of entry barriers. At most airports, slots are allocated administratively. Only at the four

airports with Federal Aviation Administration (FAA) imposed capacity limits
(Chicago's O'Hare, Washington's National, New York's LaGuardia, and Atlanta's Hartsfield) can slots be bought and
sold. Entering airlines would find these
resources much easier to acquire under
a market or auction system.
In summary, the control of scarce airport resources that are vital to the success of any market entry (the gates and
takeoff and landing slots) have been
acquired by the incumbent airlines and,
in particular, by the hub airline. This
control enables the incumbent airlines
to erect entry barriers, which make
entry more difficult for its potential
rivals. Barriers inhibit effective competition and enable the hub airline to use
its increased market power to charge
higher fares to the "to" passengers.
Conclusion and Policy
Recommendations
The relationship between competition,
concentration, and fares in the airline
industry has been considered in light of
the increased use of hub-and-spoke
networks. "Through" passengers generally have more options and lower
fares than "to" passengers. Fares to

5. See "Growing Giants: An Unexpected Result
of Airline Decontrol Is Return to Monopolies,"
The Wall Street Journal, July 20,1987, p. 1.

Federal Reserve Bank of Cleveland
Research Department
P.O. Box 6387
Cleveland, OH 44101

Material may be reprinted provided that the
source is credited. Please send copies of reprinted
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and from airports with only one hub
airline appear to be higher than the
competitive level, largely as a result of
entry barriers, although passengers in
these markets are compensated somewhat by the better service on these
routes (more flights overall, as well as
more nonstop flights). Though few analysts have advocated returning to CABtype economic regulation, some have
questioned whether some type of action
might be needed. If action is to be
taken, it should be in accord with the
specificity principle: attack the problem
at its source.
In line with this precept, public policy should move toward lowering entry
barriers. First, control of gate space
and future airport expansion must rest
more firmly in the control of airport
managers and less in the hands of the
incumbent airlines. Specifically, longterm leases should be avoided, and airlines that fail to utilize their gate space
should lose it."
Second, takeoff and landing slots
should follow competitively determined
peak load pricing at all airports. By
charging higher takeoff and landing

fees at the busiest times, peak load
pricing would alloca te airport resources
more fairly and would lower the entry
barriers that have developed under the
present system. An important additional benefit would be increased air
safety and fewer traffic delays. Airport
facilities would be more uniformly utilized over the course of the day (since
fare-sensitive tourist passengers would
switch to less costly off-peak flights),
helping to smooth out the peak demands
on the air traffic control system.
Moving in these two directions would
significantly lower the barriers that
currently exist for airlines that wish to
enter or expand their operations at the
hubs of their rivals. In turn, these
actions would lessen the ability of the
hub airline to charge higher fares to
passengers whose origin or destination
is a hub. Though it appears unlikely,
even with these recommended changes
in policy, that the promise of fully
competitive markets will ever be met
exactly in the airline industry, airline
deregulation has yielded significant
economic benefits to travelers, and
pursuing these policies should preserve
and extend the benefits.

6. Efforts of some airlines to increase service to
Cleveland have been forestalled by United's
reluctance to free up gate space it no longer
requires.

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September 15, 1987

Federal Reserve Bank of Cleveland

ISSN 0428·]276

ECONOMIC
COMMENTARY
The current performance of the U.S.
airline industry with regard to safety,
fares, and service has been a topic of
widespread concern among policymakers and the public. One aspect of this
concern is the relationship between
competition, concentration, and air
fares. Competition is required to
achieve and preserve the full benefits of
deregulation, particularly if fares are to
be set as low as possible.
Traditional economic theory predicts
that increases in concentration (as
measured by the market shares of the
largest firms in the industry) lead to
increases in market power (the ability
of firms to charge a price higher than
would prevail in a competitive market).
As a result of a wave of mergers in the
airline industry over the last year,
these measures of concentration have
risen significantly, leading to a great
deal of discussion about the negative
implications for competition and fares.
Unfortunately, much of this discussion
suffers from an inadequate understanding of the nature of the hub-and-spoke
networks that airlines formed after the
Airline Deregulation Act of 1978.
This Economic Commentary seeks to
assess the true state of competition and
concentration in the airline industry.
We first present the current measures
of concentration at both the national
and airport levels. Evidence suggests
that some types of fares are set above
the competitive level. However, the
state of competition is not as bad as the
measures of concentration indicate,
because these measures fail to account
for the effects of hub-and-spoke net-

Paul W. Bauer is an economist at the Federal
Reserve Bank of Cleveland. The author thanks
Mary Deily and Gary Whalen for helpful comments
and Paula Loboda for extensive research assistance.
The views stated herein are those of the author
and not necessarily those of the Federal Reserve
Bank of Cleveland or of the Board of Governors of
the Federal Reserve System.

Table 1 National Market
Shares of the Largest U.S.
Airlines!
Airline

Texas Air
Continental"
Eastern
United
American
Delta3
Northwest'
TWAS
Pan Am
USAir

Market Share

20.1
10.5
9.6
15.7
13.5
11.9
9.4

8.1
5.7
3.0

1. Market shares are based on each carrier's
percent of revenue passenger enplanements
on a national basis.
2. Includes New York Air, People Express,
and part of Frontier Airlines.
3. Includes Western's market share.
4. Includes figures for Republic, which was
formed by the merger of North Central and
Southern.
5. Includes Ozark's market share.
SOURCE: Data derived from "Texas Air's
Hard Bargainer," New York Times, September
16,1986.

works. The efficient operation of huband-spoke systems leads to higher concentration at the airport level, but not
necessarily to higher fares.
We then examine the sources of
market power airlines have as a result
of entry barriers. Any barrier that
makes it difficult for new firms to enter
the market limits competition, leading

1. A widely applied rule of thumb comes from
U.S. Circuit Court Judge Learned Hand: ..... [a
market share over ninety percent] is enough to
constitute a monopoly; it is doubtful whether
sixty ... percent would be enough; and certainly

Competition,
Concentration, and
Fares in the U.S.
Airline Industry
by Paul W. Bauer

to higher fares. Adjustments in the
way airports allocate resources among
airlines would go a long way toward
lowering entry barriers and increasing
competition in markets with less-thancompetitive fares.
Current Levels of Concentration
As a result of a wave of mergers in
1986, the U.S. airline industry went
from domination by 12 carriers to domination by eight carriers. Table 1 presents the current market shares of the
eight largest airlines, based on revenue
passenger enplanements. Texas Air,
which controls both Continental and
Eastern, has become the largest airline,
pushing United and American into
second and third places.
At the national level, concentration
of this magnitude probably should not
cause undue concern.' In addition, all
eight of these airlines have established
or are constructing national route networks, which could very well make the
industry dominated by eight airlines
more competitive than the one dominated by 12. The trend toward mergers,
especially over the last year, bears
watching, however.
At the local level, most individual
airports have concentration levels
higher than the national levels, but still
below the level that would be required
for monopoly pricing. Collusive pricing
in a tight oligopoly always remains a
concern; but airline profits of late have
not been excessive.
Table 2 presents the market shares
of the largest airlines (in all cases airlines with a hub at the airport) serving

thirty-three percent is not," in William Breit and
Kenneth G. Elzinga, The Antitrust Casebook:
Milestones in Economic Regulation, New York:
CBS College Publishing, 1982, p. 117.