Evaluate the View That Mergers, Such as the one Proposed Between British Airways and Iberia Airlines, Are Usually ‘good for Consumers as Well as for the Companies Involved’

Evaluate the view that mergers, such as the one proposed between British Airways and Iberia Airlines, are usually ‘good for consumers as well as for the companies involved’ [25]

A merger is a type of external growth, when two or more companies join into one. Fundamentally, mergers are beneficial for the companies involved (this is the case otherwise they would not decide to merge in the first place), although there are disadvantages for the companies involved. However, whether or not consumers benefit from mergers (ultimately monopolies being created or strengthened in the market) is more complex, and indeed there are impacts that need to be weigh up.

In an oligopoly (where there are few large firms dominating the market), such as the airline industry in which BA and Iberia Airlines operate, when mergers occur the two already large firms merge to create a monopoly (firm with over 25% market share). The companies involved benefit from this because they are undertaking (external) growth, which means it has more assets, its scale of production has increased, and more significantly it’s market share has risen. The most significant benefit for the companies is the ability to gain from economies of scale (as it’s output has increases due to the merger, its long run average/unit costs has fallen). For example, the one of the most significant economies of scale through mergers can be risk bearing economies (increase product portfolio in order to create more revenue streams and spread risk of failure), which can be achieved if the two companies involved in the merger are producing different products. This can be related to BA and Iberia Airlines, as the latter specialises in flights from and to Spain, whereas BA specialises in flights to and from the UK. Overall, the benefit is lower unit costs, which can therefore allow them to increase its profitability (or maybe gain more market share through charging lower prices). However, the benefits of economies of scale are dependent upon the extent to which larger scale production facilitates unit cost reductions. In some markets (car manufacturing), these will lead to significant benefits.

Firms can also endure cost saving methods such as rationalization. This involves the removal of duplication of resources (which come about from the two companies joining it’s assets) - such resources may be managers or even site premises (which hold usually high fixed costs). Ultimately, the company experiences immediate growth of output yet requires less resources than both companies had – therefore costs are disproportionately less.

Diagram 1

In diagram 1, LRAC1 shows the long run average costs curve of the two companies before the merger, whereas LRAC2 is the curve for the one company after merging (lower unit costs).