Strategic considerations behind the network–regional airline tie ups – A theoretical and empirical study

• Explains the contractual diversity between network and regional airlines.
• Enriches the “strategic divisionalization” literature.
• Finds market size and cost differences are chief factors of the outsourcing decision.
• Shows when airline market contracts are or are not anti-competitive.

The paper examines the strategic vertical relationship between network and regional airlines. We develop a model to illustrate how network airlines can use the contractual relationship with regional airlines as an efficient tool to simultaneously drive out inefficient network airlines and also accommodate other cost efficient network airlines in any specific market. The model is tested on U.S. data using simultaneous and sequential choice models. We find that market size, cost differences between network airlines, as well as cost differences between network and regional airlines, are the chief determinants of the network airlines’ decisions on whether or not to serve a market with their own fleet, as well as how many regional airlines to contract with.