The merger of Delta and Northwest

Though Mr Ho talked about this topic some days ago, here I want to share my further findings about this topic.

Reasons for merger:
Many US airlines including Delta and Northwest encountered the problems of starving capital and underinvestment in aircraft and customer service. Given a free choice, hardly anyone would travel with a US airline on an international flight, because of the bad meals served, the surly staff and the old aircraft. Due to consumers’ change in tastes and preferences, the demand for Delta and Northwest fell. While the demand curve shifts to the left, the price and output decreases at the same time, hence there would be a decrease in total revenue earned.

This was definitely not what the airlines wanted to see, hence they had been trying to improve their fleets since returning to profit two years ago but were once again being undermined by the rising price of fuel. Oil supply has constantly been in shortage, which drive up the oil price over the years. Rising oil price increases the cost of production of the airlines which causes the supply curve(near vertical) to shift to the left. This would result in a rise in price which was not to the airlines’ advantage, since higher price means fewer customers.

Therefore, in order to gain a considerable market share in the airline industry, two airlines Delta and Northwest decided to merge so that they can enjoy internal economies of scale thus cut cost, making themselves more competitive.

Benefits of merger:
Merging enables the new Delta to increase its market share so that the combined entity is able to compete with international airlines.

Moreover, the new Delta is able to reap internal EOS to cut costs. Here we can apply the MRFAT concepts. M: there can be bulk purchase and distribution of hardware for aircrafts as well as lower cost of advertising per unit. R: Delta’s flights are concentrated in the Southern USA, while Northwest has a more widely-spread routes. The merging of two airlines reduces the risks and potential losses as a fall in demand for one airline can be offset by higher demand for another airline in different markets. F: the new Delta is larger after merging; hence it is more credible to banking and financial institutions, hence easier to access credit and funds. A: cut costs by centralizing back-office operations and cutting management jobs. T: more investment in R&D to improve the quality of customer service and aircraft.

Problems after merging:
Firstly, despite efforts to restructure, the mergers are still lumbered with inefficient route patterns based on flying from city hubs. This puts them at a severe disadvantage to low-cost rivals such as Southwest Airlines, JetBlue and now Virgin America.

Secondly, Northwest's pilots remain bitterly opposed, due mainly to unresolved seniority issues. They have already refused to go along with proposed changes to their terms.

Thirdly, the barriers to entry remain low for the US airlines industry, therefore intense competition will persist.

Fourthly, they will also face the threat of superior financial clout and modern planes of the big European network carriers, such as Air France-KLM and Lufthansa.

Merging does help the two airlines reduce their costs and increase their market share, but whether they can remain competitive are dependent on other factors as well such as their quality of service and operation after restructuring.

References:
http://ft.onet.pl/0,8933,the_airlines_merger_that_will_not_fly,artykul_ft.html
http://www.economist.com/business/displaystory.cfm?story_id=11058463

Xu Hao