The Hub-and-Spoke Routing for Airlines Costs and

Competitiveness

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

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

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

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

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

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

Sample and Descriptive Statistics

1970-1984 21 airlines

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

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

Hub Characteristics

Centralized location which minimizes travel on each spoke

Located in large cities Upper Midwest examples(Chicago, Minneapolis, Detroit, St.

Louis)

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?

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

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

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?

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?