Vertical relations in the air transport industry: A facility-rivalry game Tiziana D’Alfonso a,b,⇑ , Alberto Nastasi a,c a Department of Computer, Control and Management Engineering, Sapienza Università di Roma, Via Ariosto 25, 00185 Rome, Italy b Department of Economics and Technology Management, University of Bergamo, Viale Marconi 5, 24044 Dalmine, BG, Italy c ICCSAI – International Center for Competitiveness Studies in the Aviation Industry, Via Aeroporto 13, 24050 Orio al Serio, BG, Italy article info Keywords: Vertical contracts Airports competition Airlines competition abstract This paper investigates contracts between airports and airlines, in the context of two com- peting facilities and three types of agreements. The downstream market consists in a route operated by one leader and n  1 followers competing à la Stackelberg in each facility. We develop a multistage game where each airport and its dominant airline decide whether to enter into a contract and which one to engage in. We find that the airport and its dominant airline have incentives to collude in each facility. Nevertheless, the equilibrium is not effi- cient in terms of social welfare: there is a misalignment between private and social incentives. Ó 2012 Elsevier Ltd. All rights reserved. 1. Introduction Liberalization has led to radical changes in the competitive structure of the aviation industry: after the initial acts of deregulation (Airline Deregulation Act, 1978), which have seen the entry of several carriers into the market, the persistence of structural, strategic and regulatory barriers created the basis for exerting market power in an oligopoly centred around hub and spoke air transport arrangements. So recent dynamics in the industry have been outlining an increase in the degree of concentration in the supply of air services, and a market polarization all around few carries with a relevant market share, challenged by smaller competitors (Alderighi et al., 2005). As a consequence, dominance allows a carrier to achieve higher bargaining power and to turn the airport–airline relation into a bilateral-monopoly (monopoly–monopsony). In addition, when an airport faces competition from other airports, either an adjacent airport sharing the same catchment area, or another major airport competing for connecting traffic, it is in each airport’s interest to ally with one airline, nor- mally the dominant carrier (Oum and Fu, 2008). Actually, competition between airports is increasing, particularly in the case of those located in different metropolitan areas, but sharing, at least in part, the same catching area (e.g. the case of major hub-and-spoke airports: Fiumicino in Rome and Malpensa in Milan, the airports of Barcelona and Madrid, Brussels and Amsterdam or Brussels and Paris); moreover, even if they are located in the same metropolitan area, and are managed by the same company (notably, Paris ADP airports, London BAA airports, Rome ADR airports, Milan SEA Airports), some com- petitive issues may arise due to possible cross-subsidies and the ensuing distortions. In this scenario, vertical relations in the aviation industry are of increasing concern and source of debate for both academ- ics and practitioners, constituting a fundamental issue because of its implications for the operation of the industry and the ensuing regulatory requirements. Indeed, evidence suggests that there may be strong incentives, which need to be analyzed, for airports and their respective dominant airlines to vertical cooperation: (i) airports can obtain financial support and secure business volume, essential for ensuring daily operation as well as long term expansion; (ii) airlines can secure key airport 1366-5545/$ - see front matter Ó 2012 Elsevier Ltd. All rights reserved. http://dx.doi.org/10.1016/j.tre.2012.03.003 ⇑ Corresponding author at: Department of Computer, Control and Management Engineering, Sapienza Università di Roma, Via Ariosto 25, 00185 Rome, Italy. Tel.: +39 035 2052010; fax: +39 035 2052310. E-mail address: tiziana.dalfonso@unibg.it (T. D’Alfonso). Transportation Research Part E 48 (2012) 993–1008 Contents lists available at SciVerse ScienceDirect Transportation Research Part E journal homepage: www.elsevier.com/locate/tre