Thursday, 12 April 2012

Vertical integration sometimes looks very strange

This odd sounding example of  vertical integration comes from Peter Klein at the Organizations and Markets blog:
The WSJ reports that Delta Airlines wants to acquire a Pennsylvania oil refinery. The reporters, quoting the ubiquitous “people familiar with the situation,” says that Delta “could save between $20 and $25 a barrel on some of its jet-fuel costs by acquiring the refinery, a big advantage as industry costs now approach $140 a barrel, up 11% so far this year.” But how? No particular economies of integration are mentioned in the article (apparently the WSJ doesn’t consider this an important point). Jet fuel is a standardized commodity, so asset specificity isn’t an issue. Organizational capabilities don’t seem to be relevant. Market power? Price discrimination? I don’t see it. In short, I can’t imagine where these cost savings would come from. Any ideas?
Delta may think that ownership of a refinery would guarantee them supply in times of uncertainty but the market for jet fuel seems to work perfectly well so I don't see why owning a refinery is necessary to ensure supply. What's the bet that the deal won't go though or if ti does it will be reversed quickly?

1 comment:

Anonymous said...

The reason that "No particular economies of integration are mentioned in the article" is because it's a tax "minimization" scheme. They can't just come out and say that tho'.

They have a company with a volatile profit margin (the airline) and one with a steady one (the refinery). When the airline is under water they're going to take profit from the refinery and pump it into the airline to keep the airline's profit at about 0.

So accountancy, not economics. Although everything is economics, but in this case we have to include the IRS in the market model.