Recent events in the airline industry have once again raised the spectre of corporate consolidation. On one side of the Atlantic, Delta and Northwest Airlines are in the throes of negotiating a merger to become the world’s largest carrier. On the other side, Air France-KLM and Alitalia recently came close to a landmark deal. In both cases, the merger process has been fraught with turmoil, with Delta and Northwest pilots in disagreement over how to combine seniority lists and with the dramatic end of Alitalia’s merger talks leaving the company teetering on bankruptcy. And in both cases, there is a sense of déjà vu. With many parties and opposing interests involved, mergers are hardly easy tasks to complete. Such conflicts have become standard fare not only in the airline industry, but also in the high-tech, financial services, and media industries, to name a few. The airline industry has been particularly abuzz with merger talk as of late, partially due to skyrocketing fuel prices, which make the cost-saving benefits of scale more likely to overcome the fixed costs of integrating operations. As the CEO of Delta recently remarked, “Oil is a game changer and this merger makes us stronger.”
Merging companies often make the case that the cost-saving benefits of consolidation will be passed on to consumers. The verdict on this is mixed. In the case of the airline industry, for example, Kim and Singal (1993) examined price changes related to a wave of mergers in 1985-1988 and argued that “the impact of efficiency gains on airfares is more than offset by exercise of increased market power.” Whether the mergers help or hurt, consumers have a vested interest in the impact that these repeated and tumultuous almost-mergers have on an industry’s prospects for consolidation. Do such conflicts delay or hasten consolidation? Why do they seem to repeat themselves? And ultimately, is consolidation inevitable?
In a recent paper, “Conflict Leads to Cooperation in Nash Bargaining,” I present a bargaining model whose theoretical implications could shed some light on these questions. I study a group of agents (these could be unions, CEOs, shareholders, governments representing taxpayers, etc.) who can form various mergers. While not all mergers may be equally profitable, all offer synergies and increasing returns to scale. These agents come to the bargaining table requesting coalition partners and demanding some amount of profit, knowing that only mutually compatible mergers may occur. The paper asks, what happens as these agents bargain over time, repeatedly requesting partners and profits to maximise their current proceeds given the most recent bargaining demands?
Like most theoretical models, this framework is at best an extreme simplification of the complex considerations involved in real-world settings. In spite of this, the prediction is a learning process possessing some of the tumultuous merger and acquisition dynamics that have been observed in various industries. The paper predicts that a strictly self-enforcing agreement between all parties – that is, complete consolidation where no group of agents is willing to break away – is bound to occur. Moreover, the paper argues that tumult offers one possible path to consolidation.
How does this happen? Here’s a simplified version of the story. First, conglomerates that cannot come to an agreement that is strictly self-enforcing may split into factions. These splits happen repeatedly until the bargainers are divided into separate conglomerates, each unwilling to work with the other conglomerates, but at least agreeing on a self-enforcing division of the profit for themselves. Stranded bargainers can easily be swallowed up by an existing conglomerate to create an even larger self-enforcing conglomerate, so eventually only conglomerates remain. And then, the most interesting dynamics begin. These conglomerates on occasion discuss the possibility of a merger, and when one conglomerate’s demands are too high for the merger to work, the merger talks fail, leaving the higher-demanding conglomerate in disarray. For that conglomerate to remain viable, at least one agent in it has to bear the impact by reducing their demands. However, any agent for whom doing so is not profitable may also secede. If this happens repeatedly, a conglomerate can be divided and conquered, with those who leave joining one conglomerate that grows to dominate the industry.
Of course, this process could take quite a while and depends heavily on the existence of positive synergies and increasing returns to scale. Suppose that we extend the model by assuming that every so often there are shocks in the economy (e.g., major changes in prices that cause industry downturns or upturns) that affect whether or not synergies and returns to scale are positive. If the merger dynamics seen in various industries are related to this type of conflict-leads-to-cooperation learning process, then we are essentially seeing snippets of a process that has not yet completed by the time that changing economic conditions reduce the benefits of merging. That is, the conditions for consolidation may not be ripe long enough for consolidation to occur, offering an explanation for why these events happen repeatedly.
Therefore, the news for companies hoping to merge and consumers worried about prices if they do is a mixed bag. Without regulation, consolidation will occur if the benefits of scale exceed the costs of merging for sufficiently long – and as in the case of prohibitively high oil prices, such conditions may not be great for companies either. On the other hand, if the conditions change before the consolidation process is complete, a company might well be in worse shape than before.
Kim, E. Han and Vijay Singal (1993). “Mergers and Market Power: Evidence from the Airline Industry,” American Economic Review, Vol. 83, No. 3, pp. 549-569
Rozen, Kareen (2008). "Conflict Leads to Cooperation in Nash Bargaining." Cowles Foundation Discussion Paper No. 1641, March.