The traditional MBA rule for justifying mergers is based on synergies that impact both cost and revenue. The general theory is that mergers are extremely challenging and costly to work out and in a vast majority of cases, lead to value destruction. It's also generally assumed that the actual synergy gained from a merger is only a fraction of whatever the analysts and consultants believe at the outset. As such, when two companies decide to merge, there has got to be a boatload of synergy. Either that, or certain bankruptcy for one or both of the un-merged companies.

When America West and US Airways merged in 2005, it was clearly that last case. US Airways was headed into likely it's final bankruptcy, with liquidation soon to follow. The deal allowed US Airways to survive, and turned America West from a regional LCC into a national competitor. In general, that merger is deemed a success if only because US Airways survived. It saved value from being destroyed even more, if it didn't also create incremental value (debatable). The fatal flaw of that merger was the pilots contracts, which remain contentious even today, 5-years later.

When Northwest and Delta merged, they got permission from their pilots before they closed the deal. This was both a choice and a necessity, as the pilots could have thwarted a deal (I say a choice because I'm sure NWA and DAL could have found some creative ways to dupe the pilots if they so wished). This deal was predicated on lots of top line and bottom-line synergy and is widely considered a success, if not from long-term value creation standards, than at least from disruption standards. The integration has been nearly seamless to the traveling public, and has set the new bar for how to integrate such large and complex companies (note: integration continues, although the bulk of it is complete). The actual cost benefit has yet to be seen (people tout numbers, but it's too early to tell for sure), but consensus is that there has at least been a revenue benefit.

Now enter United and Continental. The PR web-site for the merger looks eerily like the Northwest / Delta one from a few years back (the NWA/DAL one: newglobalairline.com, no longer exists. The UAL/CAL one is here: Let's Fly Together).

If you go straight to the heart of it -- you've got the investor benefits as both cost and revenue. In the Continental + United investor presentation, they cited $800mm to $900mm in revenue synergies and $200mm to $300mm in cost synergies. That sounds reasonable -- 3x more revenue synergies than cost synergies for this kind of merger.

So why does everyone sound so surprised when it becomes clear that the primary thesis for the merger is revenue synergy, and that comes primarily from increased market power? How else do you get revenue synergy? Does the merger suddenly allow such route optimization that allows you to magically find higher-yielding routes than one airline's individual network? Sure, there is some network benefit argument there with increasing scope and flexibility, but you need some market power increase also.

Let me settle this once and for all: It's about reducing competition, gaining more market power, and allowing the merged entity (and other airlines) to raise fares -- That's the main benefit of consolidation!

You want proof it's not about cost? Well, let's look at the cost of pre and post-merged airlines. Using MIT's Airline Data Project, we can look at Cost per Available Seat Mile (CASM), excluding fuel and adjusted for stage-length, known as the ex-fuel CESM (or Cost per Equivalent Seat Mile). This is the industry standard way of comparing costs between carriers (The data can be seen here.)

In their last year of independent operations (2005), US Airways was at 9.5 cents ex-fuel CESM, America West was at 10.4 cents, compared to a legacy carrier average of 10.4 cents. Not bad (although remember they consider themselves LCCs, who have an average of 5 cents!). Post merger, they were at 10.5 cents in 2006, rising to 11.7 cents in 2009 -- right at average.

So merging effectively took the unit costs of the lower (America West) and made it go to the higher (US Airways). Does that surprise anyone? It shouldn't. Mergers rarely allow airlines to find the lower cost of two operations, but rather the higher.

The verdict is still out on this for Northwest and Delta, but we know that Northwest had lower costs than Delta pre-merger. Will the combined carrier have costs more reflective of Delta or Northwest? Well, we know that labor generally reverts to the higher cost, since employees generally consolidate contracts towards the most beneficial (hard to get concessions during a merger). Sure, HQ costs might go down, but that takes time as employment ranks are shrunk and offices closed. HQ costs are also relatively small relative to others in the scheme of an airline (and not closing down Northwest's MSP offices or Continental's Houston offices will likely erase much of that benefit anyways).

In conclusion, it's not about costs. It's about revenue. This is why a group of "concerned citizens" are suing to prevent the United and Continental merger (see article here). A similar group also sued to prevent Northwest and Delta and ultimately failed as it was thrown out of court before getting very far. I can't imagine a different outcome here, especially since the DOJ and DOT are likely to approve the merger relatively quickly.

A report from the Government Accountability Office (GAO, found here) analyzed the competitive position of the combined carrier and found that out of 1,135 route pairs affected, only 10 would be reduced to 1 player. Meaning United and Continental are alone competing on only 10 routes. But guess what? United and Continental are both in Star Alliance, meaning they are de facto colluding on selling tickets for those routes already. In other words, combining two carriers that already have significant domestic code-sharing limits the impact of the merger. Even if they aren't allowed to code-share on those specific routes, it's a token gesture as they are already "colluding" on so many.

This is why I find the testimony of airline expert Hubert Horan so irrelevant (See Brett Snyder's analysis of that and a link to the document here). His argument that consolidation is allowing airlines to usurp consumer cash is hollow for 2 main reasons:

1) His argument is against the alliances, not against this particular merger. To argue you should stop this merger because it is one small thing in a long progression of consolidation moves is weak. The DOT/DOJ either need to debase the legitimacy of the alliance and code-sharing that goes along with it, or they let this pass. This particular merger has a negligible impact on the overall conspiracy that he  exposes in his testimony (he literally calls it a "well-planned, ongoing process").

2) The industry is hemorrhaging cash. Sure, 2010 is supposed to come up about even by the end, but it's hard to argue an industry is gouging the public when it's losing billions of dollars each year! It's fact that overall, airlines are still selling tickets to consumers for cheaper than it costs them to fly those passengers. Now you can assess cost bloat and managerial incompetence all you want, but nobody can argue that airlines are reaping major rewards at the public's expense. I'm a firm believer that in cyclical industries, companies must make major profit in the up years to protect their sustainability in the down years. So even if airlines make healthy profits in 2011, I think that's a great thing for the industry and well deserved. Think of it like pharmaceuticals. They charge hefty prices for new drugs and protect that via patent for two reasons: a) The risk of drug development needs to be hedged by reaping major profits during the patent period (applied to airlines: They need to make good money in the up years to protect the down ones), and b) Profits create incentives to keep taking risks and creating new drugs (applied to airlines: Rising prices create incentives to keep flying routes, creating transport options for the public). Airlines try to do this without patent-like regulation. The last thing they need is governmental intervention to shut off the profits at the peak.

At the end of the day, it's a price vs. demand equation that the industry balances on its own. Barriers to entry are low except at slot constrained airports, so let them compete and in the end, the consumer will win.

In summary -- mergers are about revenue, derived mostly from market power. That's not necessarily a bad thing, as natural competition will always keep that in check so long as competition exists. The point is to find the balance between hyper-competition where nobody makes money (airlines today) and monopoly power where consumers gets gouged (the fear). Today in the airline industry, we're closer to hyper-competition for most routes.

So stop all the fuss about market power increases being such a bad thing. This is what happens when competition is unsustainable, and it should be allowed to happen. If it swings too far the other way, Spirit Air Lines will take over the world. Then we'll have much bigger problems, like how to afford their carry-on fees.