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In 2010, Spirit Airlines announced that it would start charging passengers for carry-on baggage. Using a vector of route-level characteristics, we construct a matched group consisting of routes which best match those served by Spirit (the treated group). We then run a difference-in-difference estimation using the treated and matched group, and examine the impact of Spirit's baggage fee policy on its rivals' ticket prices. Our results show that Spirit's rivals reduce their prices by about 5.8% after Spirit charges carry-on baggage fee. We also look into potentially heterogeneous responses across different types of rivals. There is no significant difference in how low-cost carriers and legacy carriers respond to Spirit's policy change. However, relative to non-subcontracting carriers, those which subcontract operations to regional carriers reduce their prices further by more than 10%, including average prices (linear or log) and various other points on the price distribution. We also develop a stylized theory model to help better understand our empirical findings. | INTRODUCTIONPrice unbundling, where charging all-inclusive prices is replaced by a business model of lower basic price plus additional fees for add-ons, has become a strategic tool for firms to boost revenue. For example, hotels are known to collect fees for various services, such as early check-in, Wi-Fi, mini-bar, parking, and gym. Rental car companies often charge for Global Positioning System (GPS) navigation systems, child seats, additional drivers, mileage, early return, drop-off at different locations, and changing rental times or dates. Similarly, the practice of freemium is often observed for digital products, and on app store many apps are available for free with in-app purchase. The US airline industry, which we study in this paper, has experienced a significant increase in price unbundling in recent years as well. Examples include baggage fees, premium seats upgrade, and so forth. Airlines have also found new sources of revenue from services, such as Wi-Fi and Entertainment. Most major airlines started charging for checked bags back in 2008, and in 2017 United and American started selling Basic Economy fares for which travelers need to pay extra to bring a carry-on baggage or pick a seat. 1 Increasing reliance on ancillary revenue by airlines makes it crucial to understand the impacts of airlines' add-on pricing strategies.Carry-on baggage fee is one of the high-priced add-on items. In April 2010, Spirit Airlines (hereafter Spirit) announced that it would charge travelers $20-45 for a carry-on baggage. 2 While multiple carriers had started charging for checked baggages, Spirit was the first carrier to charge for carry-on baggages, and the only one doing so until Frontier and Allegiant followed Spirit's step in 2012 and 2014, respectively. More recently, legacy carriers also started offering basic economy fares, which put restrictions on carry-on baggages among other things.

In this paper, we use Bayesian estimation to study subcontracting network formation and pricing decisions in the U.S. airline industry with DB1B data. We find that a major carrier is more likely to enter a route in subcontracting services if its rivals have already subcontracted while regional carriers prefer to avoid competition. For existing major carriers per-route, self-service and use of subsidiaries are complementary to subcontracting, while code-sharing is a substitute. Carrier similarity and previously formed networks have significant impacts on new network formations. Taking potential endogeneity issues into account, we find that major carriers' subcontracting decreases prices by 3.4%.1 Network analysis has been used broadly in sociology (Currarini et al. [2009]; Offer and Fischer [2018]; Isakov et al. [2019]), in political science (Ward et al. [2011]), in epidemiology (Barabási et al. [2011]), and in communications and psychology (Newman [2001]; Grunspan et al. [2014]) among other fields. Applications can be found in social media, partner choice, trade relations, epidemics, scientific collaborations, board member relations, investor connections, R&D collaborations, job market and natural disaster management. Jackson et al. [2017] and Jackson [2011] provide excellent reviews.

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