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
Pre-merger
$
P3
P2
P1
P0
B
A
C
D
MC2 = AC2 (New AA)
MR
q2
MC1=AC1 (AA, US Air)
Demand
q1
Airline service
(Tickets)
- 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 nonexistent due to the constant
structure of costs.
Williamson model
Post-merger
$
P3
P2
P1
P0
B
A
C
D
MC2 = AC2 (New AA)
MR
q2
MC1=AC1 (AA, US Air)
Demand
q1
Airline service
(Tickets)
- 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
Post-merger
$
P3
P2
P1
P0
B
A
C
D
MC2 = AC2 (New AA)
MR
q2
MC1=AC1 (AA, US Air)
Demand
q1
Airline service
(Tickets)
- At point B:
-The consumer surplus is the
triangle P3BP2
- Producer surplus is nonexistent due to the constant
structure of costs
Williamson model
Post-merger
$
P3
P2
P1
P0
B
A
C
D
MC2 = AC2 (New AA)
MR
q2
MC1=AC1 (AA, US Air)
Demand
q1
Airline service
(Tickets)
- 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
Welfare impacts
$
P3
P2
P1
P0
B
A
C
D
MC2 = AC2 (New AA)
MR
q2
MC1=AC1 (AA, US Air)
Demand
q1
Airline service
(Tickets)
- 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 headto-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
Dallas, TX - DFW
Charlotte, NC - CLT
Chicago, IL - ORD
Philadelphia, PA - PHL
Phoenix, AZ - PHX
Miami, FL - MIA
Washington, DC - DCA
Los Angeles, CA - LAX
New York, NY - JFK
Destinations
Daily flights
Hub airline
before merger
Share
AA
Share US
Share New
AA
172
131
113
107
74
109
75
44
50
877
665
522
469
316
310
292
180
97
American
US Airways
American
US Airways
US Airways
American
US Airways
American
American
67%
7%
36%
5%
5%
66%
15%
18%
15%
7%
63%
7%
49%
27%
6%
34%
5%
3%
74%
70%
43%
54%
32%
72%
49%
23%
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-andspoke network
– Scheduling improvements
– Reducing service in marginally profitable and unprofitable markets
– Eliminating inefficient patterns that do not fit within the hub-andspoke 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