Pricing and infrastructure fees in shaping cooperation in a model of high-speed rail and airline competition

Highlights

• Effects of rail-air and air-air cooperation on bundle and per link prices are studied.

• Cooperation is beneficial to connecting passengers, but detrimental for local ones.

• Operators form a rail-air agreement, at the expense of passenger surplus decreases.

• Air-air cooperation provides total welfare levels higher than rail-air cooperation.

Abstract

This paper studies the effects of cooperation in a hub-and-spoke network with high-speed rail and airline competition. The distinctive elements of our analysis are the consideration of: (i) per-passenger airport and rail infrastructure fees; (ii) mixed bundling pricing by partners, and (iii) an airline duopoly in the international market. We show that partners fix the cheapest bundle price of the combined trip, that non-allied operators respond by decreasing the prices per link, and that connecting traffic increases. Per-passenger fees significantly affect the price differences following cooperation. An empirical application confirms that it is privately profitable and that welfare gains are in the range of 0.8–2.2%; these can be higher for lower fees or lower cross-price elasticity between modes.

Introduction

The growth of high speed rail (HSR) networks in developed countries has brought major changes in the supply of interurban transportation. With increased train speed, HSR has indeed become a competitor of air transport (Rothengatter, 2011), especially for short-to-medium haul passenger markets, where the rail option is better in terms of check in/out times, punctuality, frequency of service and the proximity to city centers. According to the Union Internationale des Chemins de Fer (2019), worldwide HSR lines reached 46,403 km in operation. The development of HSR services has produced a substitution effect; there has been an increase in the demand for rail transport and a traffic reallocation with regard to passenger volumes and market shares from air to rail transport (Behrens, Pels, 2012, Betancor, Jiménez, 2012, Bergantino, Capozza, Capurso, 2015). However, some railway infrastructure can also be seen as part of the air transport infrastructure (Givoni and Banister, 2006), which suggests demand complementarities between these two modes of transport. Although intermodal cooperation would involve wider choice and facilitate passenger mobility, it may distort competition in markets where both modes were former competitors.

We wish to explore the effects of cooperation in a setting where connecting passengers consider differentiated substitute bundles that are composed of complementary legs involving either air-air or air-HSR transport.¹ The distinctive elements of our analysis that adds to the received literature on airline-HSR cooperation are the consideration of: (i) per-passenger airport and rail infrastructure fees in shaping prices, traffic and welfare; (ii) partners taking into account that they fully control the price of one combination and partially control the price of some others, and (iii) an airline duopoly in the international market.

The literature has studied the case of airline-HSR competition, both theoretically and empirically (see Section 2 for a review). However, it is only recently that attention has been devoted to the analysis of modal substitutability and modal complementarity in a hub-and-spoke network. The few existing contributions include Socorro and Viecens (2013); Jiang and Zhang (2014); Xia and Zhang (2016); Jiang et al. (2017); Avenali et al. (2018). These analyses examine the effects of air-HSR cooperation when modes are horizontally or vertically differentiated while considering various types of partnership. Despite their valuable conclusions, restrictive assumptions regarding the available transport alternatives are made in the competition and cooperation scenarios. Although Xia and Zhang (2016) and Avenali et al. (2018) contemplate all connections for connecting passengers, quantity competition is assumed; none of the above papers considers infrastructure per-passenger fees. Our paper contributes to this line of research by considering price competition, to effectively account for internalization of demand complementarity under cooperation while allowing for all transport combinations. Most importantly, our analysis looks at the effect of per-passenger fees that are different per use of each infrastructure. Besides, the calibration exercise allows us to quantify the effects of rail-air and air-air cooperation agreements.

A transport network is considered with two links connecting three cities by developing a formal model to investigate the effects of cooperation when air and HSR are substitutes in one of the links and complements for those passengers that make a combined trip including the two links. In the other link passengers can take an international flight with either of two airlines. Per-passenger fees, which are different as per infrastructure, are taken into account.² With competition, there are four prices, corresponding to each price set by the operators on each link. With cooperation, partners also set the price for their combined trip, the bundle price. We show that partners increase the prices per link for a high enough degree of product substitutability. Under rail-air cooperation, airport fees increase the rail component price relative to competition while the air component price decreases. However, under air-air cooperation, rail fees always reduce the price differences in partners component prices, while airport fees decrease price differences only for large enough product substitutability. Non-allied operators typically respond by decreasing the prices per link. Partners internalize the competition that arises when pricing their complementary links; the price for the bundle or combined trip is cheaper than the sum of prices before cooperation. Besides, the bundle price is cheaper than the combination offered by non-allied operators as well as the mix-and-match combinations (having an allied and a no-allied operator). Such price differences are found to be reduced with the rail fee under rail-air cooperation; however, rail fees have the opposite effect under air-air cooperation when we consider the combination offered by non-allied operators. Finally, connecting passengers are better off when the price decrease response of non- allied operators offsets the increase in the sum of link prices by partners.

The model is also calibrated for the Valencia(Spain)-Madrid(Spain)-New York network. We may subsequently simulate the effects of HSR-air cooperation and check any differences with airline cooperation. Simulations confirm the price effects predicted by the model. Cooperation basically results in notable consumer surplus gains for connecting passengers because the bundle price is significantly lower than the sum of link prices. However, cooperation triggers effects on prices in the rest of markets leading to a redistribution of consumer surplus across markets. Cooperation is certainly profitable for partner firms, and results in welfare gains in the range of 0.8–2.2% depending on the type of cooperation and the level of per-passenger fees. Air-air cooperation has a larger impact on alliance profits, connecting passengers surplus and welfare because air services respond more to price changes as compared to rail services. Each alliance type has different effects on HSR traffic; air-air cooperation reduces total HSR traffic but increases local traffic between Valencia and Madrid, while rail-air cooperation increases total traffic although the local one falls.

We also discuss that the rail-air agreement is more likely to be proposed as it generates a larger profits increase. However, it results in the lowest value of total passenger surplus thereby raising antitrust concerns. The robustness of our findings is checked by providing a sensitivity analysis for changes in per-passenger fees and for different values of the cross-price elasticity. Lowering per-passenger fees does not affect the relative effects induced by cooperation agreements; a 1% decrease in all fees results in passenger gains in all scenarios, the most important being under rail-air cooperation. Higher values of the cross-price elasticity leads to passenger and welfare losses under rail-air cooperation. In contrast, lower values give rise to larger percentage gains in passenger surplus, industry profits and welfare. Finally, the analysis is conducted for the case of a network carrier that competes with rail and with an international airline. Our setting features a monopolization effect leading to different results because cooperation involves a loss in passenger surplus (hence a matter of concern for authorities). Although the incentives to cooperate increase, welfare decreases under the rail-network carrier agreement while it slightly increases under the other cooperation agreement.

Section 2 considers the related literature. Section 3 describes the model. Three different subsections present the equilibrium prices under competition, under cooperation and offer some results. The model is calibrated in Section 4, where the effects of cooperation are simulated. It includes subsections devoted to sensitivity analysis and robustness. Section 5 concludes.