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Savings that hurt: Production rationalization and its effect on prices

Mauricio Varela and Madhu Viswanathan

Journal of Economics & Management Strategy, 2020, vol. 29, issue 1, 147-172

Abstract: Postmerger scenarios often lead to a reallocation of resources and production across the merged entity. Production rationalization, the process of reallocating production across facilities so as to reduce total costs, results in firms equating marginal costs across markets. This results in marginal costs, and hence prices, being higher in some markets and lower in others than otherwise would be without production rationalization. This paper proposes a model of competition that elicits these effects and the resulting consequences on consumer and producer surplus. The paper also presents empirical evidence to show that production rationalization, in the form of fleet reoptimization, affected prices following the US Airways/American Airlines merger. Prices of the merged firm increased 10% on routes typically served by US Airways relative to routes typically served by American Airlines, and by 12% relative to US Airways’ rivals’ prices. Price‐cost regressions confirm such price hikes were likely due to fleet reoptimization.

Date: 2020
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Handle: RePEc:bla:jemstr:v:29:y:2020:i:1:p:147-172