Impacts of code-share alliances on airline cost structure: A truncated third-order translog estimation

The airline industry has undergone significant changes following deregulation more than a decade ago. A prominent development in recent years has been the proliferation of airline alliances. An important question arises: are alliances cost savings or competition reducing? This paper addresses the first part of the question. However, the answer has bearing on the second part as well, since results in industrial economics suggest that, unless a merger (or alliance) can substantially reduce costs, consumers are unlikely to enjoy lower prices [e.g., Farrell, J. and C. Shapiro (1990), “Horizontal mergers: An equilibrium analysis,” American Economic Review, 80(1), 107-26]. This paper estimates a truncated third-order translog cost function using quarterly firm-level data of 10 airlines for the period 1994QI to 2001QI. Using the estimated function, we assess whether alliances have any impacts on costs, and if so, the extent to which the cost structure of airlines are affected. It is found that the truncated third-order translog is an appropriate specification, and alliances do appear to lower costs. However, while the impacts are statistically significant, in economic terms the magnitude appears to be immaterial.