1. Biography for William Swan
Chief Economist, Seabury-Airline Planning Group. AGIFORS Senior Fellow. ATRG Senior Fellow. Retired Chief Economist for Boeing Commercial Aircraft Previous to Boeing, worked at American Airlines in Operations Research and Strategic Planning and United Airlines in Research and Development. Areas of work included Yield Management, Fleet Planning, Aircraft Routing, and Crew Scheduling. Also worked for Hull Trading, a major market maker in stock index options, and on the staff at MIT’s Flight Transportation Lab. Education: Master’s, Engineer’s Degree, and Ph. D. at MIT. Bachelor of Science in Aeronautical Engineering at Princeton. Likes dogs and dark beer.
I am an economist. Everyone thinks an economist can predict the stock market. If I could do that I would be so rich I could own Boeing Aircraft Company. Instead, it is the other way around.
Scott Adams

2. Value of a Nonstop William Swan Chief Economist
Boeing Commercial Airplanes Marketing
April 2004

3. Five Viewpoints Value --- What is it worth?
Price --- What does the Market Pay?
Demand --- Does it increase travel?
Market Share --- Does the airline benefit?
Cost --- Is there extra cost?

4. Nonstop Value “Everyone knows” a nonstop is “worth more”
More than “standard service”
“Standard Service” is an online connect
Less travel time
About 1.8 hours lower travel time
1 less “up-and-down” cycle (0.5 hours)
Zero connect time (1.0 hours)
No circuity (0.3 hours)
Business value = hourly wage + overhead ?
Leisure value = hourly wage – taxes ?
Less travel worry
No missed connections
Fewer lost bags
Unbroken onboard rest
One less set of take-off and safety announcements

5. Utility Value Contained in Soars
Utility value for a trip includes
Elapsed time
Price
Suitability of the time of day
Nuisance of connecting process
Market share model has Utility Function
Determines flight choices based on values
Utility function expresses consumer surplus
This is precisely the value beyond price paid

6. Distinguish between Value and Payment
Marketplace economics:
Create Value
Get people to pay for it
Part of value appears as “consumer surplus”
Surplus is value beyond fare paid
Nonstop value looks like about 2 hours of time
Market failure to “collect” is not proof
Value is still created
But marginal value of time might lower

7. Operative Statement of Value
Nonstop service is “perceptibly superior”
Compared to online connection
Dominates at least a 4-hour window of time-of-day
At least “equal value” for adjacent hours
Not superior at wrong time of day
Perceptibly superior criterion is important
Makes nonstop first choice for demand
First dibs on high-fare traffic in peak days
First dibs on high load factors in off-peak days
Based on matching fares

8. Important Implicit Assumption
Airline tactics for “superior” (nonstop) product
Match fares
Garner all high-fare demand
Garner high load factor in off-peaks
Greater revenues from this
Compared to charging higher fares
Compared to giving up “first choice” advantage
Intermediate case is tempting
Charge slightly higher fares, particularly in peaks
Not so high as to give up “first choice” advantage
Difficult balance to achieve

9. Perverse Data Possible
Data will show
Majority of local O&D traffic will be on nonstop
40-75% of market, for one-a-day
Nonstop tickets dominate average fare
Perverse outcomes for local O&D traffic
First choice for all low-fare traffic (flexible departure times)
First choice for part of high-fare traffic (partial-day time windows)
Nonstop mix could be heavy on low-fare
Scheduling incentives also increase discount loads
Local O&D discount revenues good, even discounted
Relative to pro-rated connecting traffic using this leg
Lower costs increase willingness to accept low fares
Save connecting up-and-down cycle airplane costs
Save cost of connecting passengers and bags

10. Summary of Value Nonstop creates value for sure
Roughly 2 hours trip time saved
Airline unlikely to raise prices
Gets higher revenues from being “first choice”
Dominate high-fare demand for part of day
Obtain high load factor on off-peak days
Average local fare may be low
Dominates low-fare market for all of day
Lower cost increases willingness to carry lower fares
Local revenues not diluted with pro-rate to second leg

11. Nonstop Prices Simple looks show no fare advantage
Do we believe adjusted market trends?
How about side-by-side in same market?

12. Simple Look Shows No Fare Advantage for Nonstops
Regression fare formula:
Fare = $166 + $0.046 * Distance
Trend for US domestic fares
US ticket price data by O&D available
Dummy for nonstops is no help
Fare = $169 + $0.045 * Distance - $14 * NON
Where NON=1 if served nonstop; 0 otherwise
Wrong sign, poor significance, for NON

13. Nonstop Markets Show Lower Fare Trend Before Adjusting for Market Size

14. Deeper Analysis Shows Nonstop Value is Captured
Fares decline in larger O&D markets
Fare = $ *Distance-11*Ln(Pax)
Ln(Pax) term means lower fares for big markets
Statistical Significance of Ln(Pax) term is big
Reverse causality (low fares cause high Pax) is not the explanation—because Log form attenuates
Full form with nonstops:
Fare = $ *Distance-16*Ln(Pax)+$36*NON
$36 premium for nonstop in a market
Shows value is at least partially captured

15. Bigger Markets Have Lower Fares

16. Viewing Just One Market Size Nonstop Fares are Higher

17. Nonstop Markets Trend $36 Higher, After Adjusting for Market Size

18. $36 Premium for Nonstops In comparable-sized markets, US domestic
Shows some value is captured in prices
$36 for average fare
Lower ($14) for discounts (25%ile fare)
Values coherent with value of time
This for US domestic O&D airport pairs
Same market fares confirm value

19. Nonstop Premium is $20-$50 Nonstop vs. Connect in Same US O-D Market

20. $79 Premium for Atlantic Markets
Premium higher on long trips
Time savings also higher
Coherent with utility values
Data not as certain
Less consistent, year to year
Fewer points, lower quality on market size
Pacific markets even worse
Data modified: when nonstops existed, 25% of seats offered was substituted for passenger counts. This because in DB1a data, foreign flag carriers report all onboard loads as local market in nonstop markets. So market size based on reporting is broadly overstated.

21. Atlantic Nonstop Premium is $75 Markets Served Nonstop vs
Atlantic Nonstop Premium is $75 Markets Served Nonstop vs. Connecting Markets

22. Atlantic Premium is $75-$125 Fares Nonstop and Connecting, Same O-D Market

23. Before-and-After Studies Confuse
Look at relative changes
Markets served nonstop 1995 and 2000 (2q)
Markets gaining nonstop services by 2000
Revenue growth is 23% higher
Passengers growth is 50% higher
Fares are 19% lower!!
These values without size adjustments

24. Recent Nonstops Added by Low-Fare Carriers
Comparing size-adjusted fare trends
Markets gaining nonstop service by 2000
Compared to markets already nonstop (in 1995)
Fare trend lower in markets about to be added
Fare with new nonstop barely changed
Fare in older nonstop markets up 10%
REVENUEs are still up 25%
Different expression of demand curve

25. Conclusions about Prices
Simple look says no nonstop premium
Fare trend for nonstop markets not higher
Correcting for market size “fixes” paradox
Strong trend of lower fares in larger markets
For a size, nonstops get higher fare
Results confirmed
By reasonable values of time
Nonstop carrier gets premium in same market
But not by latest LCC before-and-after studies
But recent low-fare carriers are giving value
Nonstop additions creating more revenue, not higher fares

26. Demand Increases With Nonstop
Nonstop service has higher value
Some of value may be captured in price
Remainder of value seen as demand increase
Better deal means higher demand
Increased value means higher demand curve
New demand point
Different number of passengers
Different fare
Lies on higher demand curve

27. Demand Is A Curve Not a Point

28. Adding Nonstop Increases Demand About 25%
Before and after studies
“Demand” curve measured as total revenue
Most of increase is more passengers
Fare rise can be small
25% is above nonstop fare differentials
This is US domestic travel data

29. Nonstop Market Share What is “Market” What is “Share”
Demand curve with current nonstop service
Old Demand curve plus one nonstop service
What is “Share”
Reported share of O&D passengers
Share of market total revenue
Share of high-fare (business) passengers
Share of low-fare (leisure) passengers
What is “Nonstop”
One flight, with standard fare premium?
Flight with all fares matched and capacity open
Is observed average fare premium a mix or price result?