Market Density and Low Cost Carrier Entries in the

US Airline Industry: Implications for Future Growth

Harumi Ito Darin Lee

Department of Economics
Box B, Brown University
Providence, RI 02912
E-mail: Harumi Ito@Brown.edu
Tel: (650)-329-9743
Fax: (650)-329-9743
LECG, LLC
350 Massachusetts Ave. Suite 300
Cambridge, MA, 02139
E-mail: Darin Lee@lecg.com
Tel: (617)-761-0108
Fax: (617)-621-8018

September 1, 2003

Abstract
This paper documents the growth of low cost carriers (LCCs) in the US airline industry
since 1990. We confirm that LCCs have concentrated their entries over the past decade pri-
marily on very dense city-pair markets. Moreover, we demonstrate that if LCCs continue to
penetrate markets of similar density at the same rate, the proportion of domestic network car-
rier revenue that may ultimately be exposed to non-stop LCC competition could rise sharply,
from roughly 30% today to just under 50% in the future.

JEL Classifications: L11, L93

Keywords: Airlines, Market Entry, Low Cost Carriers, Market Density
 “We’ve finally reached the point, perhaps, where [low cost carrier] penetration may be
fatal.” – David Grizzle, Senior Vice President, Continental Airlines.1

1 Introduction
The growth of low cost carriers (LCCs) in the US and elsewhere is arguably the single most
important factor currently shaping the airline industry. While LCCs accounted for 7% of US
domestic passengers in 1990, their geographic scope was fairly limited, and for the most part, LCC
service was synonymous with a single carrier, Southwest Airlines. In contrast, LCCs collectively
accounted for nearly one-quarter of all domestic origin and destination (O&D) passengers during
in 2002.2 And while Southwest is still by far the largest LCC in the US, a number of other LCCs–
namely AirTran, JetBlue, ATA and Frontier–have all been growing rapidly. The scope of LCC
service, once limited to a handful of cities, now reaches virtually all corners of the country.3
The rapid growth of LCCs has commonly been cited as one of the primary causes of the financial
crisis currently facing most large hub-and-spoke carriers.4 Indeed, competition from LCCs has
recently prompted Delta Air Lines to re-introduce a new, lower-cost sub-brand (i.e. “Song”) in
markets where they face intense LCC competition and American Airlines to discontinue its “More
Room Throughout Coach” program in roughly a quarter of its fleet.5 More generally, the continued
growth of LCCs–and the declining market “dominance” of the large network carriers–represent an
unfinished chapter of US airline industry deregulation dating back to 1978. The competitive clash
between LCCs and the major network carriers–and the resulting impact on fares and service–is
likely to be the dominant theme in the airline industry for many years to come.
Despite their growing importance, LCCs have received surprisingly little attention in the current
economics literature. A handful of studies (Morrison 2001, U.S. Department of Transportation
1996, Morrison and Winston 1995) have attempted to estimate the overall fare savings attributable
to LCCs. Other studies (Dresner, Lin, and Windle 1996, Dresner and Windle 1999, Bennett
and Craun 1993, Whinston and Collins 1992) have studied the route-level impact of LCC entry
on incumbent carriers. More recently, Boguslaski, Ito, and Lee (2002) analyze entry patterns
throughout the 1990’s in Southwest Airlines’ route system. Few in any studies however, have

1 Source: “Low cost airlines put the crunch on biggest carriers,” The Wall Street Journal, June 19, 2002.
2 O&D passengers count travellers based on the starting and ending point of their journey, regardless of whether
or not they make a connection.
3 As summarized by Duane Woerth, President of the Air Lines Pilot Association (ALPA): “Ten years ago, except

for Southwest in Texas, Arizona, and California, low-cost carriers were only a nuisance in most of the country;
now they are a major force and at least three of them are well financed with strong balance sheets... [They] now
pose a serious threat to network carriers and their futures.” Source: Report of Captain Duane Woerth to the 90th
Executive Board of ALPA, September 10-13, 2002.
4 See, for example Informational Brief of United Airlines, Inc., In the United States Bankruptcy Court For the

Northern District of Illinois, December 9, 2002.

5 Source: “American Airlines Charts Course for Brighter Future: CEO Arpey Unveils “Turnaround Plan” at

Annual Meeting,” Company Press Release, May 21, 2003.

1
directly attempted to measure the degree of LCC penetration on the major network carriers or
provide an estimate as to the potential for future LCC growth. This paper aims to fill this gap
in the literature by documenting some stylized facts about the growth of LCCs since 1990 and
estimating the potential for continued LCC expansion based on simple market density approach.
In general, we find–not surprisingly–that LCCs have primarily targeted very dense (in terms of
local passengers) city-pair markets. Indeed, of the 539 new markets entered by LCCs since 1991,
over 70% have been in markets that generated over 100 O&D passengers per day in 1990. Based on
the density profile of the markets LCCs have entered over the past 12 years, our analysis suggests
that LCC expansion is far from over. While LCCs currently offer nonstop service in markets
accounting for 31.6% of the major network carriers’ domestic revenue, our analysis suggests that the
penetration rate could eventually approach 46.9%, even under relatively conservative assumptions,
an increase of roughly 50%. More specifically, we find that of the major network carriers, United
Airlines currently faces the highest degree of exposure to nonstop LCC competition. Indeed, United
currently generates over half of its domestic revenues in markets where it competes directly with
LCCs, significantly more than most other major carriers. However, our analysis also suggests three
other carriers–Continental, Alaska and American–will face potential domestic revenue exposure of
roughly 50% in the future.
The remainder of this paper is organized as follows. Section 2 documents some stylized facts
about the growth of LCCs in the US since 1990 and provides some measures of past and current
network exposure for the major hub-and-spoke carriers. Section 3 profiles the pre-entry density
of market entered by LCCs over the past decade, and provides an estimate of potential LCC
penetration in the US. Brief conclusions are summarized in Section 4.

2 The Growth of US Low Cost Carriers Since 1990

We begin our analysis by documenting some stylized facts about LCC growth in the US since 1990.

2.1 The Data

Passenger and traffic data for our analysis is taken from the US Department of Transportation’s
(DOT) OD1B Origin and Destination Survey, a 10% sample of all tickets reported by US scheduled
passenger carriers. For the purposes of this study, we consider all domestic revenue passengers in
the data set travelling on round-trip and one-way itineraries with three or fewer coupons per
directional leg. Data for flight frequencies and entry were derived from the DOT’s T100 segment
database. Our unit of observation is a non-directional city-pair market. Thus, we assume that (a)
passengers are in the same “market” regardless of the direction they are travelling and (b) airports

2
within the same metropolitan area are substitutes for one another.6

2.2 LCC Growth in the US: 1990-2002

By any measure, the LCC segment of the domestic US airline industry has grown dramatically
since 1990. Table 1, for example, summarizes O&D passenger market shares for the largest LCCs
as well as the major network carriers for the period 1990-2002.

Table 1: Market Share of Domestic Origin & Destination Passengers, 1990-2002

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

AirTran† 0.0 0.6 1.4 1.0 0.9 1.2 1.3 1.5 1.6 1.9
ATA 0.1 0.1 0.1 0.4 0.7 1.0 0.9 0.8 1.1 1.2 1.3 1.6 1.9
Frontier 0.0 0.2 0.3 0.3 0.3 0.5 0.6 0.6 0.8
JetBlue 0.3 0.8 1.5
Southwest 7.0 8.2 9.6 11.3 12.7 13.6 14.1 13.8 13.8 14.3 14.9 16.2 15.8
Other LCCs 0.2 1.9 2.4 2.3 2.8 2.4 2.2 2.2 2.0 2.1 1.8
Total LCCs 7.0 8.3 10.0 13.7 16.3 18.4 19.0 18.2 18.5 19.4 20.6 22.9 23.7

Alaska 1.8 1.9 1.9 2.0 2.6 2.9 3.1 3.0 3.1 3.0 2.9 3.0 3.3
America West 3.8 4.3 3.6 3.4 3.3 3.4 3.3 3.3 3.2 3.2 3.4 3.6 3.9
American 14.8 15.3 16.2 14.7 12.7 11.5 11.0 10.7 10.8 10.4 10.9 10.8 14.1
Continental 6.8 7.4 7.4 7.3 8.3 7.2 6.5 6.6 7.0 6.9 6.7 6.9 6.7
Delta 12.6 15.0 15.5 15.0 14.8 13.4 14.8 15.7 16.2 15.9 16.1 15.2 16.0
Northwest 7.1 7.3 7.5 7.3 7.1 7.4 7.5 7.6 7.0 7.6 7.6 7.6 7.7
TWA∗ 3.9 3.8 4.1 3.6 3.6 3.6 3.5 3.6 3.9 3.8 3.8 3.2
United 11.5 12.8 12.7 11.8 11.2 11.9 11.9 12.1 13.2 12.7 11.7 11.0 10.5
US Airways 14.0 13.1 12.4 11.8 12.3 10.7 10.1 10.7 10.7 10.2 10.4 10.3 8.8
Other Carriers 16.6 10.8 8.8 9.5 7.7 9.7 9.2 8.7 6.6 6.9 5.9 5.6 5.3
Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
∗ Acquired by AMR Corporation in 2001. † Data for AirTran and ValuJet combined.

Source: U.S. DOT OD1B Database, 1990-2002.

A number of observations from Table 1 are noteworthy. First, while Southwest was the only
LCC with a national market share exceeding 1% in 1990, there are currently four LCCs with
domestic market shares exceeding 1%, with a fifth (Frontier) likely to be joining this group in the
near future.7 Second, the combined market share of the LCCs has increased steadily each year
since 1990 with the exception of 1997.8 Finally, Southwest–the world’s largest low cost carrier–is
on the verge of becoming the largest US carrier in terms of domestic O&D passengers. Indeed,
during 2001, Southwest carried more domestic O&D passengers than any other US airline.

6 For the purposes of our analysis, we group airports in the following metropolitan area: Washington, D.C. (BWI,

DCA, IAD), San Francisco Bay Area (SFO, SJC, OAK), Los Angeles (LAX, BUR, LGB, SNA, ONT), Houston
(IAH, HOU, EFD), Dallas (DAL, DFW), Chicago (ORD, MDW, GYY), Detroit (DET, DTW), New York City
(LGA, JFK, EWR, HPN) and Miami (MIA, FLL).
7 Frontier recently announced plans to expand its fleet from 37 to 62 aircraft by 2008. Source: “Frontier to add

29 owned, leased Airbus jets”, Reuters, August 1, 2003.

8 The decline in LCC market share in 1997 followed the crash of ValuJet Flight 592 in May of 1996 which resulted

in increased FAA and media scrutiny on the operations of LCCs (Transportation Research Board 1999).

3
2.3 Market Density and LCC Entry

It is well understood that LCCs typically enter city-pairs with high passenger density, since these
markets allow them to exploit their comparative advantage in providing quick-turn, point-to-point
service. Moreover, until recently, the networks of most LCCs were not large enough to generate
a significant amount of “flow” or connecting traffic, and thus, the markets they entered typically
needed to be dense enough to support nonstop service purely with local passengers. Figure 1
summarizes the number of the largest 1,000 domestic city-pair markets (which account for roughly
75% of all domestic O&D passengers) served by LCCs since 1990. While LCCs only served 74 of
the largest 1,000 city-pairs in 1990 on a non-stop basis, this number had grown to 419 by end of
2002. If we also include all the markets that LCCs served on a nonstop as well as a connecting
basis, the number of top 1,000 markets where a LCC carried at least 5% of the O&D passengers
had increased over four-fold from 159 in 1990 to 704 by the end of 2002.

1000

900

800

700

600

500

400

300

200

100

0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Served by LCC with Nonstop Service Served by LCC with 5% or Greater O&D Marketshare

Notes: Nonstop service requires at least 5 weekly roundtrips. Source: U.S. DOT DB1A and T100 Databases.

Figure 1: LCC Presence In the Top 1,000 City Pair Markets

2.4 Network Carrier Exposure to LCCs

Although the route systems of the LCCs collectively reach most areas of the US, the competitive
impact of LCCs on the large hub-and-spoke carriers varies significantly. Table 2 summarizes each
major network carriers’ proportion of domestic passengers and revenues exposed to nonstop LCC
service between 1990 and 2002. Specifically, we consider passengers (and their associated revenue)

4
to be “exposed” to nonstop LCC service if they travel in a market served by an LCC offering
at least five nonstop round-trips per week. Table 2 indicates that United’s network is currently
the most highly exposed, with slightly more than half of its domestic passengers and revenue
generated in direct competition with LCCs, while Northwest’s network–following the bankruptcy
of Sun Country in 2001–is currently the least exposed with roughly 20% of its passengers (and
16.1% of its revenues) generated in markets with nonstop LCC service. Moreover, while none of
the major network carriers had more than 5% of their domestic revenues exposed to nonstop LCC
competition in 1990, five of the seven carriers now have more than one-quarter of their domestic
revenues (and one-third of their domestic passengers) directly exposed to LCC competition.

Table 2: LCC Nonstop Overlap with Major Network Carriers, 1990-2002

Proportion of Domestic O&D Passengers in Markets with Nonstop LCC Service

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
Alaska 6.8 8.3 5.5 33.4 34.5 36.2 46.8 45.8 40.3 52.8 39.6 38.2 38.7
American 10.8 10.5 10.0 11.8 13.9 17.6 19.6 20.4 21.6 30.9 37.5 36.6 39.8
Continental 6.9 4.7 4.6 12.3 18.1 20.5 24.1 22.7 23.1 27.3 32.5 38.3 42.3
Delta 4.5 5.0 4.0 10.1 20.9 24.3 28.9 27.5 28.6 30.4 32.0 34.8 35.3
Northwest 4.5 3.4 3.0 3.3 5.8 9.5 14.4 18.7 19.0 32.6 32.9 29.2 20.8
United 8.9 15.0 13.0 20.9 25.9 34.0 43.8 43.0 42.2 46.2 47.0 48.0 54.2
US Airways 9.9 6.3 4.5 4.8 7.4 16.3 18.4 17.6 18.3 15.9 22.9 26.3 24.1

Proportion of Domestic Revenue Generated in Markets with Nonstop LCC Service

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
Alaska 2.7 2.3 2.6 25.3 24.8 25.3 32.1 32.5 27.9 42.5 27.9 26.9 26.5
American 4.0 3.8 4.4 6.6 9.1 10.9 13.0 14.4 15.8 22.6 27.9 30.8 34.2
Continental 2.6 2.1 2.4 8.0 12.0 13.5 15.8 15.7 16.4 20.3 24.1 32.8 36.9
Delta 1.6 1.7 1.6 6.2 13.7 17.9 20.1 19.9 20.0 21.8 23.4 26.3 27.2
Northwest 1.5 1.0 1.1 1.5 2.9 4.9 8.4 12.4 12.1 27.9 28.4 24.7 16.1
United 3.0 4.6 5.6 12.0 17.0 20.1 28.9 29.3 30.3 35.4 37.0 42.2 51.0
US Airways 4.9 2.5 2.0 2.8 4.9 12.3 13.3 12.6 12.7 10.5 15.9 18.9 18.7
Source: U.S. DOT DB1A Database, 1990-2002.
Notes: LCCs include Air South, Access Air, AirTran, American Trans Air, Eastwind, Frontier, JetBlue, Kiwi,
Morris Air, National, Pro Air, Reno, Southwest, Spirit, Sun Country, ValuJet, Vanguard and Western Pacific.

Since downward price pressure from LCCs does not necessarily require nonstop LCC service
within a market, Table 3 summarizes the percent of O&D passengers and revenues which are
exposed to LCC competition, where we define a market to be exposed to LCC competition if there
is a single LCC in that market with at least a 5% share of O&D passengers.

5
 Table 3: Low Cost Carrier Overlap with Major Network Carriers, 1990-2002

Proportion of Domestic O&D Passengers in Markets with LCC Competition

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
Alaska 6.8 8.3 8.9 56.2 54.1 65.8 76.9 75.8 69.3 69.0 64.5 64.6 64.5
American 18.4 18.4 17.2 21.4 23.6 31.6 33.8 31.5 37.0 48.3 53.5 56.4 62.4
Continental 15.6 12.8 14.0 23.7 30.5 38.9 42.8 37.4 38.9 45.8 52.5 64.6 66.4
Delta 7.8 8.5 7.3 16.1 29.0 36.0 41.8 36.5 39.1 43.8 44.5 52.1 53.3
Northwest 10.4 9.6 9.4 10.5 17.4 23.7 26.3 25.1 34.9 47.4 48.5 52.6 48.1
United 13.6 19.4 17.0 31.8 35.4 47.4 56.5 54.3 57.0 62.2 64.9 68.5 72.0
US Airways 10.8 7.8 5.9 7.0 10.4 23.7 24.3 16.2 23.0 23.8 34.1 42.6 42.9

Proportion of Domestic Revenues Generated in Markets with LCC Competition

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
Alaska 2.7 2.3 6.1 47.0 44.0 53.9 64.8 65.0 59.0 59.8 53.0 52.3 51.8
American 10.7 10.8 11.1 16.1 17.7 24.2 25.2 23.9 30.2 39.7 43.9 50.0 57.1
Continental 11.3 10.4 12.1 20.3 27.0 32.4 35.2 31.9 33.1 39.7 43.5 58.3 60.1
Delta 4.3 4.7 4.5 11.6 21.4 28.8 31.5 28.8 31.0 35.4 36.1 42.5 44.0
Northwest 7.6 7.3 7.4 8.8 13.8 17.8 19.5 18.2 26.8 41.8 44.1 46.8 42.6
United 7.2 8.9 9.5 22.9 25.3 33.3 41.2 40.2 46.5 53.4 57.2 64.1 69.0
US Airways 5.8 3.9 3.4 4.5 7.9 18.7 17.7 11.6 17.1 17.9 25.5 32.6 35.1
Source: U.S. DOT DB1A Database, 1990-2002.
Notes: LCCs include Air South, Access Air, AirTran, American Trans Air, Eastwind, Frontier, JetBlue, Kiwi,
Morris Air, National, Pro Air, Reno, Southwest, Spirit, Sun Country, ValuJet, Vanguard and Western Pacific.

3 LCC Entry & Future LCC Penetration: A Market Den-

sity Approach
Continued growth by LCCs is likely to be the driving force behind the future evolution of the
deregulated US airline industry in the coming years. In light of the rapid expansion of LCCs since
1990, the current financial troubles at most of the legacy network carriers, and the expansion plans
of LCCs such as JetBlue and AirTran,9 some natural question that comes to mind are what is the
degree to which LCCs can continue to grow and how will such growth impact the legacy network
carriers? In this section, we attempt to provide some insight into these questions.
Our methodology for estimating the LCCs’ penetration potential makes use of the fact that
pre-entry passenger density in a city-pair market has historically been the single most important
criterion–by far–driving LCC entry decisions (Transportation Research Board 1999). By analyzing
the pre-entry passenger density of the markets LCCs have entered (on a nonstop basis) over the
last decade and the passenger distribution of today’s markets, we should be able to gain a better
understanding of the long term potential for LCC penetration in the US and the likely exposure
of the major network carriers to continued LCC growth.

9 While JetBlue has a current fleet of 46 Airbus aircraft, they currently have orders and options allowing them to

expand their fleet to 290 aircraft by 2011. Likewise, AirTran recently announced orders for up to 100 new Boeing
737-700 aircraft. Source: Airline websites.

6
 At the outset, we stress that our predictions in this section are likely to represent the lower
bound for the actual economic exposure of network carriers to future LCC expansion. Indeed, our
predictions underestimate the likely future impact of LCCs for a number of reasons. First, while
entry by a LCC on a nonstop basis clearly poses the greatest threat to an incumbent carrier’s
passenger and revenue base in that market, connecting service on LCCs also has the effect of
significantly depressing fares, especially for leisure travellers. Since the number of connecting
markets grows exponentially as new cities are added to a LCC’s route system, the revenue impact
from connecting competition increases in a non-linear fashion as LCCs add additional cities to their
networks. Second, our airport groupings are based largely on those in the Official Airline Guide,
which tend to understate the true catchment area of LCCs’ service, especially for price sensitive
leisure travellers who may be willing to drive significant distances to fly at the lowest available fare
(Morrison 2001). For example, our analysis does not consider the potential impact of Southwest’s
flights to and from Louisville on markets served by Delta to and from Cincinnati, even though
many travellers travelling to or from Cincinnati may be willing to drive the required two-hours
to Louisville in order to take a lower priced Southwest flight. Third, for the purposes of our
analysis, we do not count America West as a low cost carrier, since it has only recently adopted
pricing policies which resemble those of traditional LCCs.10 Fourth, improvements in aircraft
technology have increased the range of the twin-engine, single aisle aircraft typically purchased
by LCCs, allowing them to serve transcontinental markets while maintaining a single (or very
small) aircraft-type fleet. Finally, the emergence of financially strong LCCs other than Southwest
will likely lessen the impact of regulatory restrictions on entry imposed by the Wright and Shelby
Amendments.11 Indeed, a number of “newer” LCCs such as AirTran and Frontier now serve the
Dallas metropolitan area with service to and from DFW airport.
Table 4 summarizes, by passenger density, the markets entered by LCCs between 1991 and
2002. We define entry as new non-stop service and require that the entrant performed at least
twenty round-trips per month for at least six months during the year of entry. We stratify markets
into nine “density bins,” representing the average daily number of O&D passengers travelling in the
market in either direction. Since passenger traffic is stimulated in markets following LCC entry, we
consider the market’s density in 1990. Thus, column (c) demonstrates and that LCCs collectively
began serving 539 new city pair markets during the twelve years between 1991 and 2002. In order

10 Moreover, America West has recently announced new nonstop service in a number of dense markets that
currently do not have nonstop LCC service such as Boston-San Francisco and Boston to Los Angeles. Source:
“America West Airlines Announces First Nonstop Transcontinental Flights,” Company Press Release, August 11,
2003.
11 The Wright and Shelby Amendments prohibit carriers from serving Dallas’ Love Field (DAL) and any airport

outside of Texas, Louisiana, Arkansas, Oklahoma, New Mexico, Mississippi and Alabama with aircraft of 59 seats or
greater. These restrictions have are particularly noteworthy with respect to Southwest, as its corporate headquarters
is located at Love Field.

7
to get a sense of the proportion of markets in each density bin entered by LCCs over this period,
column (d) summarizes the number of markets in each bin that were not yet served by LCCs at
the start of 1991. Column (e) computes the percentage of available markets–at the beginning of
1991–that were entered by LCCs over the twelve year period.

Table 4: Density Stratification of LCC Entries, 1991-2002

Density Passengers Number of LCC Total Number of Percent Current Number of

Bin Per Day Entries (1991-2002) Markets in Bin (1991) Entered Markets∗
(a) (b) (c) (d) (e) (f)
1 ≤5 14 28,637 0.0 29,012
2 6–25 27 4,945 0.5 5,134
3 26–50 30 1,286 2.3 1,259
4 51–75 49 564 8.7 526
5 76–100 30 303 9.9 279
6 101–250 136 608 22.4 625
7 251–500 113 281 40.2 215
8 501–1000 76 124 61.3 78
9 1001+ 64 83 77.1 37
All 539 36,861 1.5 37,165
Source: U.S. DOT DB1A and T100 Databases, 1990-2002.
∗
Based on passenger density in 2002. Excludes markets served by LCCs as of December, 2002.
Excludes intra-Hawaii markets.

Not surprisingly, Table 4 demonstrates an overwhelming preference by LCCs to enter very dense
markets. Between 1991 and 2002, LCCs entered over three-quarters of the markets that generated
1,000 or more daily passengers during 1990 (bin 9) and over 60% of the markets generating between
501 and 1,000 daily passengers (bin 8). In contrast, LCC entry rates drop sharply once market
density falls below 500 passengers per day, and for all markets generating fewer than 100 day
passengers (bins 1-5), the entry rate was less than half of one percent.
In order to gauge the number of new non-stop markets available for future LCC entry, column
(f) summarizes the number of markets–not served by LCCs at end the of 2002–by density bin. Not
surprisingly, column (f) tends to indicate that there are somewhat fewer very dense markets (i.e.,
those with greater than 500 passengers per day) available today for LCCs to enter compared to the
beginning of 1991. However, the route structures of many of today’s LCCs rely more heavily on
connecting traffic than they did in 1991, and thus, it has become increasingly feasible for LCCs to
enter less dense markets than they did during the early 1990s. Indeed, JetBlue’s order of several
100-seat EMBRAER aircraft indicates that their future entry strategy will focus–at least partly–on
these serving some of these less dense markets.

3.1 Network Carrier Exposure to LCCs: Current and Potential

What insights from Table 4 can be drawn with respect to the current and potential future levels
of LCC exposure faced by the large US network carriers? Table 5 summarizes the proportion of

8
domestic O&D passengers and revenues generated by each of the major network carriers in 2000,
by market density bin.12 For example, Table 5 indicates that 51.8% of American Airlines’ domestic
passengers in 2000 flew in markets generating more than 1,000 passengers per day and that these
passengers accounted for 52.8% of the airline’s domestic revenue. The Potential Exposure column is
computed by multiplying and summing each carriers’ passenger and revenue distribution in Table
5 by the historical entry rates summarized in Table 4 column (e).13 The potential exposures are
then compared to each carrier’s 2002 non-stop exposure from Table 2.

Table 5: Carrier Passenger/Revenue Distribution & Potential Nonstop LCC Exposure

Proportion of Domestic Passengers in Density Bin Potential 2002

1 2 3 4 5 6 7 8 9 Exposure Exposure
Alaska 2.8 5.5 3.5 4.2 2.7 8.3 4.5 14.2 54.3 55.0 38.7
American 2.4 5.4 3.9 2.8 2.2 9.4 10.7 11.2 51.8 53.9 39.8
Continental 1.9 4.2 3.4 2.7 2.1 10.0 12.8 17.6 45.2 53.6 42.3
Delta 3.0 8.6 6.7 4.6 3.6 12.5 10.9 15.1 35.2 44.5 35.3
Northwest 6.4 11.0 6.8 4.8 4.0 13.3 10.0 13.6 30.0 39.5 20.8
United 3.2 5.1 4.2 2.9 2.3 8.5 8.0 9.9 55.8 54.8 54.2
US Airways 3.6 6.7 5.7 4.0 3.7 15.0 14.0 14.2 33.0 44.0 24.1
Total 3.3 6.9 5.2 3.7 3.0 11.4 10.7 13.4 42.4 48.6 36.9

Proportion of Domestic Revenue from Density Bin Potential 2002

1 2 3 4 5 6 7 8 9 Exposure Exposure
Alaska 5.0 7.7 4.9 5.5 3.0 9.9 5.5 13.5 45.0 48.3 26.5
American 2.6 5.4 3.9 2.9 2.1 9.1 10.6 10.7 52.8 54.1 34.2
Continental 2.3 4.4 3.4 2.9 2.0 9.1 12.4 16.7 46.8 53.9 36.9
Delta 4.1 10.6 7.7 5.3 3.8 13.1 11.6 13.9 29.9 40.3 27.2
Northwest 7.4 11.9 7.1 5.1 4.0 14.3 10.0 12.7 27.4 37.2 16.1
United 3.7 5.3 4.2 3.0 2.3 8.7 8.3 9.3 55.1 54.1 51.0
US Airways 4.7 8.1 6.4 4.3 4.0 15.9 16.0 13.7 26.9 40.1 18.7
Total 4.0 7.6 5.5 4.0 3.0 11.5 11.1 12.5 40.7 46.9 31.6
Source: U.S. DOT DB1A Database.
Notes: Total figures represent the sum of the seven carriers.

Overall, Tables 4 and 5 combine to paint a chilling prediction for the major network carriers.
If LCCs continue to penetrate markets–by density–at their historical rate, the total proportion
of network carrier revenue exposed to nonstop LCC competition would increase sharply relative
to current (2002) levels from 31.6% to 46.9%. Likewise, the proportion of domestic passengers
currently flying on network carriers who have access to non-stop LCC service will also rise from
36.9% to 48.6%. Moreover, it is important to stress that these estimates likely underestimate the
potential for LCC growth and market penetration. In addition to the reasons cited earlier, we
have constructed the density bins in Table 4 according to the market traffic in 1990 in order to
avoid counting the traffic volume generated by the LCC entries. The traffic in many individual

12 We chose 2000 as our base year to compute these distributions since it is the last full year of data which is

unaffected by the events of September 11th.

13 For example, Alaska’s potential revenue exposure would be computed as: (5.0 × .000) + (7.7 × .005) + (4.9 ×

.023) + (5.5 × .087) + (3.0 × .099) + (9.9 × .224) + (5.5 × .406) + (13.5 × .613) + (45.0 × .771) = 48.3%.

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markets has grown considerably since then, pushing more markets into higher density bins thus
making them more attractive for LCCs to enter.
Table 5 also indicates that the potential exposure to LCCs varies significantly across carri-
ers. For example, while Alaska, American, Continental and United all face potential passenger
exposure of between 48%-54%, the potential exposure for Delta, Northwest and US Airways is
significantly less (37.2%-40.3%). Not surprisingly, these three carriers all operate at least one hub
in relatively small cities (in particular, Cincinnati (Delta), Charlotte and Pittsburgh (US Airways)
and Memphis (Northwest)). Since LCCs have traditionally focussed their entry on the most dense
markets, the relatively higher proportion of “thin” markets served from these smaller hubs may
provide carriers with a degree of insulation versus LCCs. It is important to stress, however, that
even among these carriers, LCC exposure is likely to increase dramatically in the years to come
and thus have serious competitive consequences. For example, the proportion of both Northwest’s
and US Airways’ domestic revenue which may be exposed to nonstop LCC competition could more
than double in the coming years.

4 Conclusions
This paper documents the growth of low cost carriers (LLCs) in the US airline industry since 1990.
In 2002, LCCs collectively carried nearly one in four domestic O&D passengers, a dramatically
higher proportion than just twelve years earlier (7%). Moreover, we document the increasing
overlap between the networks of the legacy hub-and-spoke carriers and those of the LCCs. The
growing overlap of their respective networks has resulted in strong competitive pressures on the
fares–and in turn–the revenues of incumbent carriers. In short, the rapid growth of LCCs has
quickly become the primary force reshaping the competitive landscape of the US airline industry.
It is important to note that the recent growth of LCCs is not limited to the US. Indeed, LCCs also
represent the fastest growing segment of the airline industry in Canada, Australia and throughout
Europe.
Using a market decomposition analysis, we found that LCCs have primarily targeted markets
with high traffic densities that allow them to leverage their comparative cost advantage. Since
many incumbent network carriers also generate a substantial portion of their revenue from these
same dense markets, they face–or will likely face–even greater exposure from the LCCs as they
continue to grow and enter new markets. We estimate that in the long term, an additional fifteen
percentage points of the incumbent network carriers’ revenues will potentially be exposed to new
nonstop LCC competition, increasing their total exposure from roughly 32% today to roughly
47% in the future. Moreover, our analysis is based on a number of conservative assumptions, and

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consequently, may be interpreted as the lower bound for the potential economic exposure facing
the legacy network carriers.
LCCs are no longer a niche segment of the airline industry whose influences are limited solely to
particular geographic regions or leisure travellers. Indeed, over the last decade, LCCs have emerged
as an industry phenomenon that have fundamentally altered the market structure and competitive
landscape of the airline industry, both in the US and elsewhere. As LCCs continue to grow, many
markets with high traffic density appear to have become more “contestable” than they have ever
been. Indeed, the relative ease of entry and the perceived “contestability” (Baumol, Panzar, and
Willig 1982) of airline markets was one of the theoretical backbones of airline deregulation. In the
current state of the industry, entries are swift, prevalent and often successful, partially confirming
what the original planners of airline industry deregulation envisioned of the post-deregulatory era
(Bailey and Panzar 1981, Bailey and Baumol 1984). However, in light of recent bankruptcy filings
by both United Airlines and US Airways, the long-term sustainability of some of the large hub-and-
spoke carriers is now in question. Consequently, the evolving direction of LCC versus full-service
network competition will likely be the primary issue facing policy makers, business leaders, as well
as academic researchers in the coming decade.

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