Saturday, November 14, 2009

Airline Merger & the Horizontal Merger Paradox?

British Airways and Iberia recently announced they were merging. According to the article, the main benefits of the merger were costs synergies - specifically overhead or fixed costs synergies. One of the counter-intuitive results from the Cournot model revolves around something called the horizontal merger paradox. The horizontal merger paradox states that if firms in the same industry merge, and the merger is not a merger to monopoly - in other words after the merger there are still firms competing in the market - that the post-merged profits of the combined firms are less than the pre-merged firms profits.

One of the resolutions to the horizontal merger paradox is that the merged firm can be more profitable if it can lower its fixed costs by merging. This is what BA and Iberia are claiming they are going to do. The problem is that firms seem to over-estimate the fixed cost synergies, and thus we see some evidence that the post-merger profits are less than anticipated.

I wish to be clear, I am not saying that this is a profit-reducing merger. All I am saying is that this merger seems like a good example of the horizontal merger paradox.

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