Modeling Cost Competitiveness: An Application to the Major North American Airlines

Significant changes occurred in the North American aviation market during the 1990s and early 2000s: the growth of low cost carriers, the open skies agreement between Canada and the United States, the formation of global alliance networks such as Star Alliance, OneWorld, Sky Team, and Wings, mergers between major airlines such as American (AA) and TWA, Air Canada (AC) and Canadian Airlines International (CAI), etc. These events have affected productivities, unit costs, average yields, and consequently financial situations of airlines. Therefore, it is useful to measure the consequences of these changes on airline performance.

This chapter (Chapter 38) measures and compares performance of 10 major full service carriers in Canada and the United States in terms of their unit cost competitiveness (see also Chapter 20). To accomplish this objective, in the first stage, the total factor productivity (TFP) of the 10 sample airlines is measured, and the sources of TFP differentials are investigated in order to compute the residual TFP index which is a measure of (pure) productive efficiency. In the second stage, a neoclassical variable cost function is estimated, and the variable cost function is used to decompose unit cost differentials of the sample airlines into various sources including differences in input prices, network characteristics, output composition, and productive efficiency.