Do enhancements to loyalty programs affect demand? The impact of international frequent flyer partnerships on domestic airline demand

Airlines’ reorganization of their networks from point-to-point to hub-and-spoke after deregulation resulted in a significant number of airports being dominated by a single domestic carrier. While there is evidence that hubs allow for lower costs and higher frequency, there is also evidence that airlines are able to exercise market power on routes departing from their hubs. Both academics and policy analysts have argued that frequent flyer programs (FFPs) may be at least part of the reason why. Prior research, however, has not disentangled the impact of FFPs from the other advantages possessed by dominant airlines. This paper uses a novel empirical approach to estimating the relationship between FFPs and demand at dominated airports. In the mid 1990s, domestic airlines increasingly entered into FFP partnerships with international airlines. While these agreements had no direct impact on the quality of individual domestic flights, they did significantly change consumers’ earning and redemption opportunities in domestic airlines’ FFPs. I exploit time-series variation in the extent and scope of airlines’ international FFP partnerships to evaluate the economic impact of enhancements to FFPs. The paper’s main set of results establishes that, controlling for the other advantages of airport dominance, enhancements to an airline’s FFP are associated with increases in an airline’s demand on routes that depart from airports at which it is dominant. The impact of enhancements to FFPs increases with an airline’s level of dominance at an airport, with the effect on routes departing from the airline’s most dominated airports (more than 60% of departing flights) more than double the effect on routes out of airports at which at has between 40% and 60% of flights. To the extent that the airports at which enhancements to FFPs affect demand are the same airports at which FFPs themselves affect demand, then the estimated pattern of coefficients clearly suggests that FFPs confer an advantage to specifically those airlines that have a very dominant position at an airport.

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