Saturday, August 17, 2013

AA and US Airways merger: a curse for consumers?

Last week the department of justice (DOJ) thwarted the merger between AA and US airways that would have made the world's biggest airline company. The move was based on the premise that this will lead to an increase in airfares and consumers will end up paying more. This is because there will be less competition in the airlines sector, and airlines will have a lesser incentive to reduce fares to attract the customers. A simple example is comparison of consumer surpluses in a monopoly with a single durable good compared to a symmetric Cournot duopoly with durable goods, where in a monopoly prices are higher, consumer surplus is lower compared to the duopoly.

Interesting things to observe about the airline industry are:
  1. High entry barrier, it takes a lot of capital to setup an airline business.
  2. Firms are identical in terms of product, most airlines operate from same terminals and similar airplanes with similar flight times.
  3. Price discrimination is usually achieved through segmenting customers based on time of purchase of tickets, type of ticket (refundable, non-refundable, economy, business) etc. 
  4. Operating costs such as airline ticket counters, airline staff (pilots, attendants, scheduling and operations) is highly symmetric across airlines and there is a good chance these costs will push down when companies merge. The existence of airline partnerships across the globe is one such measure to reduce these operating costs.
  5. Owing to long gestation periods and break-even point, companies try to secure profits by mergers and alliances to avoid bankruptcy and secure cash-flow for operations. In this case both AA and US airways argument was that this merger is beneficial to secure their failing future.
Solution: My view on this is that airlines should be given an opportunity to merge if they are ready to pass on the benefits operational synergies achieved through the merger to consumers. If department of justice can help secure this, then it could be a big win for the sector as well as consumers.

Several articles discusses this issue and its impact on different parties including:


No comments:

Post a Comment