teaching horizontal mergers to undergraduates: the case of
TRANSCRIPT
Teaching Horizontal Mergers to Undergraduates: The Case of American Airlines and US Airways
Introduction
• In this lecture we analyze the welfare impacts of the American Airlines and US Airways merger– Merger description– Williamson model• ‘Naive’ model of horizontal mergers
– DOJ and FTC Horizontal Merger Guidelines• Government decision making process on mergers
– Policy implications
Merger Description
• On December 9, 2013 world's largest airline was created
• $11 billion dollar merger of AMR Corporation and US Airways Group, parent companies of two out of four remaining legacy airline companies in the United States, American Airlines and US Airways
• Recent mergers in airline industry – United Airlines and Continental Airlines in 2010 – Northwest Airlines and Delta Airlines in 2008
Merger Description• Largest carrier in the world– More than 6,700 daily flights to 336 locations in 56 countries
worldwide– About $40 billion in operating revenue– More than 100,000 employees
• Affected airports– Dallas, TX– Charlotte, NC– Chicago, IL– Philadelphia, PA– Phoenix, AZ
Merger Description
• Potential welfare impacts– Positive• Efficiency gains
– Cost savings from integration of facilities, labor , information systems and acquiring similar productive capacities
– Network benefits
– Negative• Welfare losses
– Merged airline increases market power on many routes– Leads to price increases, service decreases and welfare losses
Williamson Model
• Modeling trade-offs from a merger of two competing firms
• Simplified model of governmental decision making on merger approval
• Focuses on cost reductions due to company synergies and welfare losses due to market power
• Does not consider more complicated circumstances like entry, political economy, etc.
Williamson model
A
B
$ P2
P1
P0
q2 q1 Airline service (Tickets)
MC1=AC1 (AA, US Air)
MC2 = AC2 (New AA)
Demand MR
C
D
P3
Pre-merger- Competitive airline industry- American Airlines and US Airways initially operate as competitors, charging a price equal to marginal cost.- MC1=AC1
- Market equilibrium is found at point A, with a price of P1 per ticket and a quantity of q1 tickets- The consumer surplus is the triangle P3AP1
- Producer surplus is non- existent due to the constant structure of costs.
Williamson model
A
B
$ P2
P1
P0
q2 q1 Airline service (Tickets)
MC1=AC1 (AA, US Air)
MC2 = AC2 (New AA)
Demand MR
C
D
P3
Post-merger- Monopolistic airline industry- The New American Airlines reduces costs by exploiting newly found economies of scale, shown by MC2=AC2.- The New AA maximizes profit by equating marginal revenue with marginal cost, - New market equilibrium at point B, associated with a price of P2 per ticket and a quantity of q2tickets.
Williamson model
A
B
$ P2
P1
P0
q2 q1 Airline service (Tickets)
MC1=AC1 (AA, US Air)
MC2 = AC2 (New AA)
Demand MR
C
D
P3
Post-merger- At point B: -The consumer surplus is the triangle P3BP2
- Producer surplus is non- existent due to the constant structure of costs
Williamson model
A
B
$ P2
P1
P0
q2 q1 Airline service (Tickets)
MC1=AC1 (AA, US Air)
MC2 = AC2 (New AA)
Demand MR
C
D
P3
Post-merger- At point B: - Deadweight loss is triangle BAC -Due to ticket price increases and service reductions - Efficiency gains are area P1CDP0 - Due to reductions in duplicative operation costs by integrating facilities, labor, and information systems and acquiring similar productive capacities.
Williamson model
A
B
$ P2
P1
P0
q2 q1 Airline service (Tickets)
MC1=AC1 (AA, US Air)
MC2 = AC2 (New AA)
Demand MR
C
D
P3
Welfare impacts- The merger is welfare enhancing is the deadweight loss (BAC) is smaller than the efficiency gains (P1CDP0 )- The merger is welfare decreasing is the deadweight loss (BAC) is greater than the efficiency gains (P1CDP0 )
DOJ and FTC Horizontal Merger Guidelines (HMG)
• “The Agencies (DOJ and FTC) seek to identify and challenge competitively harmful mergers while avoiding unnecessary interference with mergers that are either competitively beneficial or neutral” (DOJ and FTC 2010)
• The process pursued in evaluating the proposed merger of American Airlines and US Airways
• Address each section of the HMG relevant to the merger
HMG - Evidence of Adverse Competitive Effects
• Types of evidence– Actual effects observed in consummated mergers– Direct comparisons based on experience– Market shares and concentration in a relevant
market– Substantial head-to-head competition– Disruptive role of a merging party
• Sources of evidence
HMG - Evidence of Adverse Competitive Effects
• Sources of evidence– Merging parties– Customers – Other industry participants and observers
HMG - Targeted Customers and Price Discrimination
• Impact of a merger on various groups of customers
• Price discrimination– Leisure travelers– Business travelers
HMG – Market definition
• All city pairs served by both of the carriers, including nonstop and connecting services– Hubs like Dallas, TX; Charlotte, NC; Chicago, IL;
Philadelphia, PA; Phoenix, AZ• No close substitutes for travel beyond 300
miles for both leisure and business travelers
HMG - Market Participants, Market Shares, and Market Concentration
• Market participants – All the competing airlines in the relevant market,
including airlines that fly between the same city pairs the newly merged airline
• Market concentration– Measured using the HHI– Forecasted increase in HHI beyond 2,500 in more than
1,000 city pairs in which the airlines competed head-to-head prior to the merger,
– Average increase in HHI of over 200 points.
HMG - Market Participants, Market Shares, and Market Concentration
• Market shares
TABLE 1. Proposed Hubs of New American Airlines - Sorted by Number of Daily Flights
Airport Destinations Daily flights Hub airline
before merger Share AA Share US Share New
AA Dallas, TX - DFW 172 877 American 67% 7% 74% Charlotte, NC - CLT 131 665 US Airways 7% 63% 70% Chicago, IL - ORD 113 522 American 36% 7% 43% Philadelphia, PA - PHL 107 469 US Airways 5% 49% 54% Phoenix, AZ - PHX 74 316 US Airways 5% 27% 32% Miami, FL - MIA 109 310 American 66% 6% 72% Washington, DC - DCA 75 292 US Airways 15% 34% 49% Los Angeles, CA - LAX 44 180 American 18% 5% 23% New York, NY - JFK 50 97 American 15% 3% 18%
HMG - Coordinated Effects
• Impact of the merger on coordinated interaction• More concentrated airline industry will lead to
lower coordination costs, especially among the legacy airlines– Less likely to engage in price competition – More likely to pursue both explicit and tacit collusion– Signaling through transparent price publishing – Cross-market initiatives
HMG - Entry
• More ‘slots’ in ownership of legacy airlines• Special agreements with airport authorities
regarding the use of gates, terminals and other airport facilities.
HMG - Efficiencies
• Agencies are most likely to consider either verified merger specific efficiencies or efficiency claims substantiated by similar past experience
• US Airways-American Airlines merger predicted efficiencies of about $1.05 billion in 2013
HMG - Efficiencies• Cost efficiencies
– Economies of scale– integration of facilities, labor , information systems and acquiring similar
productive capacities• Network efficiencies
– Adding destinations to the network– Offering more round-trip options on existing routes– Converting interline service into a single line service– Optimizing the combined fleet of aircraft across a larger hub-and-spoke
network– Scheduling improvements– Reducing service in marginally profitable and unprofitable markets– Eliminating inefficient patterns that do not fit within the hub-and-spoke
network model
Policy Implications
• Another merger in an already concentrated industry• Policy implications of the merger are still contested and
it may take some time to observe its full welfare effects• Previous airline mergers lead to higher fares, declines in
services, and increases in the cost of ancillary services such as luggage and meals
• US Airways-American Airlines merger is unlikely to bring many benefits to customers and further increases the hold of the industry by the legacy airlines