On The Choice between Strategic Alliance and Merger in the Airline Sector: The Role of Strategic Effects

We consider a market with three competitors, two of which decide to cooperate. Firms first choose capacity under demand uncertainty, then compete in quantities after the uncertainty has been resolved. We specify strategic alliance (SA) as an agreement where two airlines jointly choose capacity and divide it among themselves. Contrary to the full merger case, after demand is revealed the alliance members market their capacity shares independently. Our contribution is twofold. First, we extend the well known Salant et al. (1983) result to the case of strategic alliance, that forming an alliance is not profitable unless cooperation leads to cost synergies. Second, we find that the profit of the cooperating firms is greater under SA than under full merger. These results imply that the SA always requires less cost saving than the merger in order to be profitable. © 2006 LSE and the University of Bath