Merger of the US Airways and American Airlines

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Table of Contents

Abstract
Introduction
Reasons and Consequences of the Merger
Benefits of the Merger to Travelers
The Regulatory Framework that Control Monopoly
The Economic Models that Explain the Merger and Monopoly
The Application of the Theoretical Model
Developing the Model
Conclusion
References

Abstract

Mergers of companies can result in monopolies or in different kind of amalgamation, which does not benefit the consumers. The current merger of US Airways and American Airlines may result in a monopoly causing increased prices of airline services. In other words, among the majority is that the merger can create a monopoly.

However, merging the two companies creates the largest airline carrier in the world. In essence, the largest airline carrier has amassed huge resources that it can use to control prices. In other words, due to its size, the airline carrier can create price increases and eliminate services of smaller airline carriers in the industry. However, through various reasons and economic models, the merger will not result in a monopoly.

Introduction

The US Airways and American Airlines officially merged in December 9, 2013 to become the American Airlines Group, Inc. The publicly traded holding firm has its headquarters in Fort Worth, Texas. With the merger, the American Airline Group has been touted as the largest airline company with over three hundred destination hubs around the globe and operating in over fifty countries.

Even though the merger has been publicized as the most successful, the merger has been received with mixed reactions particularly concerning the possibilities of creating an airline monopoly. However, the merger of the two firms has presented opportunities as well as benefits to the airline industry (Shlleifer & Vishny, 2006).

Reasons and Consequences of the Merger

Mergers involve the acquisition as well as the combination of two firms. In the case of acquisitions, one firm absorbs the other completely.

However, in combinations, merging firms transfer or combine their operations. Firms often merge to cut costs as well as gain bigger market share. For instance, America Airways merged with the US Airlines in order to cut operation costs. Further, in order to bring American Airline out of insolvency, the amalgamation was inevitable.

Mergers are normally a gradual process (Gowrisankaran, 2009). In this case, the merger of the two firms is expected to last after two years. In other words, the airlines will take approximately two years to amalgamate completely. The merging process will involve transfer of assets, liabilities, staffs as well as other operations of the two firms.

Besides, with new operations in place, the clients of the two airlines are also expected to be amalgamated. With the merger of American Airlines and US Airways, travelers are expected to experience several changes. The two airlines claim that the merger will create an increased value of services to the customers.

Even though the merger has not been completed, the airlines will continue operating separately under a single corporate union. The merger is also expected to be completed in approximately two years bringing the clients of the two airlines together. In addition, the travelers’ flight schedules would not be affected since the group’s trademark will be gradually modified without causing confusion among the travelers.

However, the opponents argue that the merger between the companies would cause severe harms in the airline industry including poor services delivery and hiked prices. In addition, the critics of the merger argue that the amalgamation would hinder the prevention of the America Airlines Group Inc.’s anticompetitive consequences.

Moreover, the opponents argue that the merger would lead to monopoly created through operational barriers that reduce the entry into the industry as well as development of other airlines (Kamien & Zang, 2000). Further, the merger would offer entry obstacles to economical airlines emanating from increased operational costs and reduced prices of airline services.

Besides, the new entrants in the airline industry will also have to contend with the corporate discount initiatives, devotion to the frequent flyer policies as well as the hazard of getting antagonistic reactions from the clients already devoted to the dominant American Airline Group, Inc.

On the contrary, the proponents of the merger argued that the amalgamation had numerous benefits to the airline industry. In fact, the supporters of the merger assert that the combination of American Airline and US Airline would not lead to a monopoly.

Benefits of the Merger to Travelers

The merger means that the new-fangled mega-airline industry would have many flights as well as flight routes. In essence, travelers would be offered with the required expediency and comfort. In other words, even though the travelers may pay relatively higher prices, convenience and comfort offered by the American Airlines Group would be appealing to the customers.

In the absence of mergers, airlines often offer low-ticket prices to travelers. As such, the airlines normally go out of business as well as ceasing operations in some routes. Under the circumstances that international domestic airlines fail to operate, travelers are normally being inconvenienced due to unavailability of options to the international route networks.

Therefore, mergers are seen as the remedy to such problems since the merging companies have enough resources to operate amid hard economic times. Even though many would argue that the merger would create a monopoly resulting in increased prices of the airline services, the benefits the merger would provide to the clients surpasses the costs involved.

The Regulatory Framework that Control Monopoly

The merger between the US airlines and American Airways would not lead to the creation of monopoly within the industry due to a number of factors. The first preventing factor is the regulatory framework that does not allow monopoly in any form.

In essence, the federal government has continued to create several anti-trust acts that regulate the mergers between firms in the industry. The anti-trust regulatory framework has been put in place to prevent the creation anticompetitive mergers.

The anti-trust laws have achieved major milestones in regulating the operations and conduct of firms in order to ensure fairness in competition as well as avert creation of a monopoly.

The creation of statutes has been critical in restricting cartels and collusive practices limiting trade. In addition, the anti-trust laws are capable of putting ceilings on mergers between organizations with the motive of minimizing competition.

Further, the statutes have been significant in proscribing the conception of domination as well as the misuse of monopoly power.

Considering the Sherman Anti-trust Act of 1890, the application of the anti-trust statute has continuously varied since its inception. For instance, the Supreme Court decreed that amalgamations between directly competing firms meant contravention of section 1 of the Act thereby hindering the creation of monopoly through horizontal mergers.

Further, through the application of the rule of reason test, the courts are capable of scrutinizing the effect of mergers on the creation of monopolies and only approve the fusion of firms that do not end in a monopoly.

Besides, Clayton Anti-trust Act of 1914 has provisions that restrict the formation of a monopoly by barring anticompetitive amalgamations. For example, the provisions of the Act are used by the courts to overturn mergers and acquisitions that promote creation of monopolies as well as anticompetitive amalgamations.

Further, the Federal Trade Commission Act of 1975 prevents biased methods used by firms in competition and put into effect antitrust laws.

In the United States, the courts often apply strong rules and remedies concerning anti-trust laws to prevent the creation of monopolies from mergers. In fact, the courts have the power to compel the merging firms to be separated if deemed to create a monopoly. In other words, the merger between American Airlines and US Airlines risk separation if the airlines embrace monopoly.

Further, the American Airlines Group, Inc. would suffer from massive fines if the organization would be involved in the creation of a monopoly. In reality, section two of the Sherman Act of 1890 holds any person or organization that monopolizes or attempts to monopolize operations liable to a criminal offence and legally responsible for prosecution.

Through the application of antitrust acts, other airlines will be capable of accessing restricted airports leading to augmented levels of consumer gains. In fact, the merger of US Airlines and American Airlines would be able to transfer numerous slots as well as gates and airports that would be utilized in the establishment of services in nonstop routes. As such, the consumers are relieved from paying higher fares.

The Economic Models that Explain the Merger and Monopoly

The merger between US airlines and American Airways have been predicted to cause increase in prices. As indicated, the increase in prices would result from monopolistic behaviors exhibited by the American Airlines Group, Inc., a new larger firm that has been formed.

However, there are laws that protect against such behavior. Moreover, the economic models on mergers do not predict increase on prices unless the merging companies were monopolies. Besides, the mergers have various effects on smaller airlines particularly low cost carriers operating within the same industry.

Economically, firms enter in mergers in order to increase their resources base. In this case, the two airline carriers entered into a merger agreement in order to increase their resources thereby augmenting the competitive advantage. In addition, because of the merger, the American Airlines Group will take advantage of the economies of scale as well as increase their customer base.

Even though many people may interpret the actions of the airlines as a monopolistic behavior meant to drive smaller airlines in the industry out of business, economic experts argue that it would be impossible to drive smaller firms out of business since market forces are actually working against the large firm.

The reason is that within the competitive market like the American airline industry, every firm has the opportunity to grow and expand depending on its capabilities. In other words, smaller firms have in their possession various strategies that can be applied to penetrate the market dominated by the newly merging airlines.

As indicated, the main reason for the merger of the two major American airlines is to increase their resources and strategically position within the world market. On the same note, some economic models predict increase in prices of airline services due to monopolistic behaviors. However, such kinds of strategies have negative feedback on the part of the firm.

Moreover, the argument is that competing firms may use the low price strategy to penetrate and capture a sizable market share. In other words, the merging firms would utilize the available resources to lower the prices in order to remain competitive. In fact, the American Airlines Group Inc. will constantly utilize the resource base capabilities to increase its competitiveness in the market.

The reason why the American Airlines Group is unlikely to be monopolistic is that it does not control prices of the product. Even though the firm has the capabilities of lowering the prices to the point where the smaller airlines are incapable of competing, the clients normally determine the prices.

In other words, larger client base may prefer the prices charged by the smaller airlines as opposed to the lower prices of the larger airline. Besides, the consumer preferences are not only determined by prices but also various factors including the quality of services. The possibilities of reduced quality of airline services due to the mergers are very high.

As a result, smaller firms can take advantage and offer distinctive services to increase their competitiveness in the market. Essentially, competitive markets operate in such a way that no firm can claim to have control over the market prices. American Airlines Group will be operating in a competitive airline industry. Therefore, the firm will have no control over prices.

The Application of the Theoretical Model

Whether the merger of the two American airlines will result in monopoly, competition or the combination of the two concepts can only be accurately proved through the application of economic models. In fact, the suggestion is that the merger will not result in any of the two concepts (Salant, 2003). The dynamic model is often applied to understand the business processes behind such mergers.

The dynamic models take into consideration the action of the dominant firm and the reactions of various smaller businesses in the industry. Moreover, the models also take into consideration the forces of demand and supply in the actions of the merging companies. Researches often indicate that mergers are probable under the circumstances when the supply is inelastic.

In other words, monopolistic competition results in mergers when the demand is elastic. Under the circumstances that the conditions are not met, the capability of the dominant firm to increase prices through a monopoly is curtailed.

Moreover, as the rate of discount increases, the ability to monopolize the industry becomes limited. In fact, American Airlines Group faces the stated conditions. Essentially, American Airlines Group will be operating under inelastic supply conditions thereby reducing its capability of monopolizing the industry (Holmes, 2006).

Moreover, the demand in the airline industry is elastic and the discount rate is constantly increasing. The conditions do not allow the monopolization of prices as well as the industry. However, in the end, there is likelihood of increasing the prices.

Developing the Model

Three important opposing forces are central to the understanding of the problem. In fact, mergers and monopolies result in maximum profits, which is significant in consolidating the firm’s capital. However, the presence of smaller firms offering competition limits the merger process. In addition, smaller firms have the capability of investing in the industry capital as opposed to larger firms.

The reason is that negative effects of the future prices are likely to affect larger firms in relation to smaller firms (Perry & Porter, 2005). The long-run result is the declining market share of large firms. The effects of the opposing forces make the conditions of merger unknown particularly in an attempt to operate under monopoly.

The developed models incorporate all the forces with an endogenous merger process. In fact, the models apply the industry dominant firm faced with many demand curves for a homogenous product. Essentially, the industry is composed of one dominant firm that may result from mergers and a continuum of several smaller firms that offer competition. The process model goes through two important stages.

The two stages include the merger and the output phases. In the merger stage, the dominant firm acquires the capital. During the output stage, the firm determines the prices. However, the competing smaller firms will normally choose the production levels for the market prices determined by the dominant firm (Gowrisankaran, 2009).

The dominant firm provides the residual demand. In the model, the production technology is assumed constant with capital and labor as inputs. The assumptions are necessarily important in the production process such that the dominant firm monopolizes and controls the flow of capital.

The model predicts that smaller firms have the power to stop the dominant firm from monopolistic activities. The reason is that the business processes of the smaller firms would stop the dominant firm from setting prices. The model work best in perfectly competitive market where individual smaller firms have the power to establish own prices depending on demand.

Essentially, in perfect competition, individuals firms have no control of the prices. Firms have no power to set prices. In other words, the prices are determined by the market demand. In the model, the free-rider-effect is stronger against the merger.

In using the model to understand the situation, three important results are observed. First, monopoly will only result when the firms merging operated in monopolistic competition or were monopolies. On the other hand, firms merging under competitive industry will not result in monopoly (Cheong, 2002).

In other words, firms operating under monopoly will merge to be monopoly while firms operating under competitive industry will remain to be competitive. The reason for the monopoly is that mergers are motivated by the capital and the profits. As a result, the mergers under monopoly will maximize on all the industry capital limiting the gains of the merger.

In term of competitive results, free-rider effect dominates. Within the competitive market structure, the smaller companies often have maximum value in each unit of capital. The case is contrary to the dominant firm that earns less for each unit of capital.

The result of the whole process is that the smaller firms have to remain in their original position since the position does not yield negative values. In the circumstances that the merger started in the middle of monopoly and competitive market structure, the likelihood of concentrating into competitive structure is high (Shlleifer & Vishny, 2006).

Conclusion

As indicated the merger between American Airways and US airlines will not result in a monopoly as indicated from both legal and economic model viewpoints. The regulatory framework does not allow mergers that end in monopoly. In addition, the economic models do not predict actions that result in monopoly. Therefore, the fear that the merger will result in monopoly is unfounded.

References

Cheong, K. S. (2002). Mergers and dynamic oligopoly. Journal of Economic Theory, 3(1), 306-322.

Gowrisankaran, G. (2009). A dynamic model of endogenous horizontal mergers. Journal of Economics, 30(16), 56-83.

Holmes, T. (2006). Can consumers benefit from the policy limiting the market share of a dominant firm? International Journal of Industrial Organization, 14(2), 365-387.

Kamien, M. & Zang, I. (2000). The limits of monopolization through acquisition. Quarterly Journal of Economics, 81(16), 465-499.

Perry, M. & Porter, R. (2005). Oligopoly and incentives for horizontal merger. American Economic Review, 75(14), 219-227.

Salant, S. (2003). Losses from horizontal merger: The effects of an exogenous change on industry structure. Quarterly Journal of Economics, 98(4), 185-199.

Shlleifer, A. & Vishny, R. (2006). Large shareholders and corporate control. Journal of Political Economy, 94(6), 461-488.

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