4 May 2017

The development and economics of airline networking

Arvid writes:*

Currently, all major airlines in the world have a home-base; an airport from which a majority of their flights operate from. For KLM this is Schiphol Amsterdam, and for American Airlines, this is Dallas/Fort Worth international airport. These main airports function as a hub and link with smaller airports called 'spokes'. This networking system quickly and unexpectedly developed from 1978 onwards after the deregulation of the airline industry in the US, but it was not incorporated by all airlines, and is contrasted by a different networking strategy called ‘point-to-point’ which is mostly used by budget airlines – which I will refer to as LCC; lower-cost-carrier – like Ryanair and Southwest Airlines. In this post I will discuss why the hub-and-spoke system developed in the airline industry, and explain the economics behind this system.

When in 1978 the ‘Airline Deregulation Act’ was introduced it was expected that the industry would keep developing a linear and point-to-point system as it had been operating under the regulation. However, relatively quickly almost all airlines developed a hub-and-spoke networking system (H&S), to capture the passenger from the origin to the destination. A lot of airlines that did operate a point-to-point network mostly failed. For a more extensive history on the development of the airline industry you should read Flying off Course by Rigas Doganis.

The concept of hubbing was developed for a more effective transportation of passengers. It requires that flights from different airports, which are at the spokes of a network, arrive at the hub at approximately at the same time. This enables passengers and baggage to connect with different flights in a relatively short time, after which all the planes leave in a wave of departures. This whole process is called a complex, and by timing a complex correctly it was possible to do multiple a day. American Airlines for example has around 8 complexes a day at Dallas-Fort Worth.

Figure 1: American Airlines's hub at Dallas-Fort Worth is obvious**
The economic benefit of the hub-and-spoke system is that it is optimized to cover a large geographical area. Passengers can travel between any two cities in the route system with one connecting stop at the hub. It enables a complete coverage of an entire network with the least amount of routes. For example if you have 10 destinations, with the H&S system you would only need 9 routes to connect all the airports, whereas an airliner would need 45 routes if it used the point-to-point system. This system also immediately has the added benefit of ‘economies of scale’ as explained in this great paper [pdf]. Because passengers arrive at the hub airport in waves, the airline can offer more seats per route which decreases the cost per seat. Second, there is also the advantage of density, due to this system of complexes routes can be served multiple times a day, with little down time on the ground. The benefits of density and scale according to Gerald N. Cook in this paper make it easier for airlines to add another connection because it requires only one extra route, and little extra capital cost.

Figure 2: Southwest Airlines does not use one hub and has more short routes**
However, the limits to the H&S system are becoming apparent with the rise of LCC’s. First, Gerald argues that a large amount of passenger have a hub airport already as their origin airport and therefore all the services that are in place to accommodate connecting passengers are an extra expense. Furthermore, extra stops at a hub are expensive due to extra ground time, landing fees. and a significant increase in fuel consumption during landing, taxiing, and take-of. Third, flights from hub airports are susceptible to delays due to capacity constraints and unpredictable circumstances such as a snow storm at Heathrow can delay a multitude of connecting flights.

Bottom line: The airline industry has developed two networking structures, with the hub-and-spoke system being the most prominent one. Although this system has the benefits of economies of scale and density, the limits and downsides are becoming more visible.

* Please comment on these posts by students in my growth & development economics course. It really helps if you highlight unclear analysis, alternative perspectives, better data, etc.

** Source: Author-created in R using data from openflights.org

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