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The Hub-and-Spoke Routing for Airlines Costs and Competitiveness

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Presentation on theme: "The Hub-and-Spoke Routing for Airlines Costs and Competitiveness"— Presentation transcript:

1 The Hub-and-Spoke Routing for Airlines Costs and Competitiveness

2 Background Airline industry during regulation
Entry into the airline industry was limited Between 1950 and 1974 CAB rejected applications from 79 possible new airlines Airline routes were awarded by Civil Aeronautics Board (CAB) Airlines cannot create the route network in the most efficient way

3 Airline Deregulation Act of 1978
1975 route suspension ended CAB allows competition in a market where incumbent was satisfactory Deregulation Act of 1978 Allowed entry into markets unless incumbents can show not in publics best interest

4 Effect of Deregulation
Creation of the Hub-and-Spoke system by major airlines Routes quadrupled in 18 months Lower airfares (yield) Better service Many market exits

5 Advantages of Hub-and-spoke
Consolidation of passengers (economies of density) Decreased number of routes Increase demand (frequent flights) Consolidation of activities (personnel, maintenance, etc.) Decrease costs

6 Implications Hub-and-spoke should decrease the cost of airlines
The more intense the hub-and-spoke system, the lower the unit cost should be Historical data (pre and post deregulation) should indicate this trend – Study in 1986

7 A Measure of Hub-and-Spoke
% of departures from hub airports (hub ID by airlines) % of departures from N airports with largest departures Top 3% of departures coming from locations Upper limit = .5

8 Sample and Descriptive Statistics
21 airlines

9 Econometric Model Airline cost is a function of: Labor Fuel
Capital and materials Average stage length Average load factor Number of airports (points) Outputs Hubbing intensity

10 Results Model estimation result – Table 4
For every 1% increase in hubbing, unit costs fall by .11% It does not seem like much, but in 1984 the airline industry may have saved 2 billion dollars due to increased hubbing

11 Hub Characteristics Centralized location which minimizes travel on each spoke Located in large cities Upper Midwest examples (Chicago, Minneapolis, Detroit, St. Louis)

12 Implications for Competitiveness
Desirable hub cities do not have the capacity to become hubs for all airlines Most desirable cities for hubs are already taken Airlines without hubs at desirable locations may be in disadvantage Monopolistic behavior?

13 How About Point-to-Point?
Big exception of Southwest (SW) SW uses P2P – should have higher costs than others Provides cheap fares (Figure 1) The only profitable carrier in the US (see Table 1) Other majors are in and out of financial ruin since deregulation Similar models emerging in foreign countries

14 Other Way Round? Hubbed fims begun to offer short-haul P2P to keep SW at bay E.G. United Airlines, the largest airline in the world at the time, started United Shuttle (which made direct flights) Used $1 billion to fight against SW This and similar attacks all failed

15 Other Way Round? (cont.) Clearly, the benefit of hubbing does not lie in the ability to charge low prices Increase in non-hub routes by majors – 134 new nonstop routes in the last year only (New York Times) Why? Is theory not working?

16 Discussion Questions What are the pros and cons of Hub-and-spoke system? What is the future of hub-and-spoke system? Are there any other ways than hub-and-spoke to increase density and lower cost? From the passenger viewpoint, what are the pros and cons of hub-and-spoke system? Can hub-and-spoke work as a barrier to entry? Under what circumstance? What is the solution(s) for capacity problem?

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