Question

Two physical therapy firms are exploring the possibility of merging. The data for each of these firms are:

                                    Firm #1                                  Firm #2                     

Visits:                          12,000                                    14,400                       

Marginal Cost:            $25.00                                     $25.00                       

Fixed Costs:                $75,000                                 $100,000                  

Market Share:            10%                                      12%                              

After the merger, marginal costs are expected to stay the same at $25.00 per visit. Combined fixed costs are estimated to remain at $175,000. If there were no loss of patients, the combined volume for the merged firms would be 26,400 visits, or a 22% market share.

The overall price elasticity of demand for physical therapy is estimated to be -0.40.

The Assigned Analysis

1. Utilize Cornot’s economic pricing model and Lerner’s index of monopoly power to calculate the firm-specific elasticity that Firms 1 & 2 each face and the profit-maximizing price for each. Using these prices, calculate the current total costs, revenues, and profits for each of the firms.

2. (i) Calculate total costs, revenues, and profits for the merged entity, assuming current price and patient visit levels. (ii) Using the merged organization’s higher market share, calculate the profit-maximizing price it theoretically might charge and estimate total revenues, costs, and profits under this scenario.

3. How realistic/probable is the scenario you just analyzed in (B) (ii) above? Provide an explanation for your answer.

4. What is a more realistic scenario with respect to post-merger pricing and visit volume? Provide estimates of total revenues, costs, and profits under this scenario.

5. What additional information might you seek and (pricing) strategies might you pursue to maximize the marketshare and profitability of this merger?

Answer 1