Avis, Hertz and Dollar Merger Game: The Mating Dance Continues

Includes: CAR, DTG, HTZ
by: Cheep Talk

by Sandeep Baliga

Hertz (NYSE:HTZ) made a merger offer to Dollar (NYSE:DTG), an offer that made it difficult for Dollar to approach another suitor. But Dollar is trying to wriggle out of its chastity belt and flirt with Avis (NASDAQ:CAR). Each marriage carries the risk that the Feds step in before the relationship is fully consummated. After all the merged firms might have the market power to hike up prices. A preliminary analysis suggests given the current segmentation of the rental market into leisure and premium classes, antitrust issues are less of a threat to merger to Hertz than for Avis:

The rental car market is segmented into two categories: premium and travel/leisure. Hertz and Avis classify themselves as premium car rental companies renting to travelers on business and those who otherwise are less sensitive to price and more attuned to service and car quality. Both companies also operate in the leisure market. Budget is Avis’s leisure market subsidiary, while Hertz has its Advantage leisure subsidiary. Hertz has offered to divest itself of this subsidiary as part of this transaction and in response to any antitrust objections.

Dollar Thrifty classifies itself as travel/leisure.

At first blush, this would appear to give Hertz a free pass, as the company does not define itself as being in Dollar Thrifty’s market segment and the Advantage subsidiary is quite small.

But even in this scenario, market power issues arise. In the existing market structure, Dollar sets its prices ignoring the impact they have on Hertz and Avis profits and focussing on just its own profits. In particular, Dollar captures some premium customers from Hertz and Avis if its prices are sufficiently low. This kind of cutthroat competition is the essence of capitalism and is to be lauded.

But if there is a Dollar-Hertz merger say, the competition from the leisure car rental division cannibalizes the profits of the premium car division. There is less of an incentive for Dollar-Hertz to cut prices and leisure rental from the firm will become more expensive. Now, Avis can raise the price of Budget cars. This will allow Dollar-Hertz to raise leisure car prices more and a lovely – for firms! – spiral of rising prices will ensue. And this is without any collusion between the firms- the basic forces of competition are dampened by the merger.

How big is this effect? It’s going to depend on substitution effects between premium and leisure segments. All my colleagues who do empirical I.O. will be gainfully employed and I hope I will be drinking good wine at their houses (yes, they will each have multiple houses).