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Merger

A corporate strategy to combine with another company and operate as a single legal entity

What is a Merger?

A merger is a corporate strategy to combine with another company and operate as a single legal entity. The companies agreeing to mergers are typically equal in terms of size and scale of operations.

 

Merger

 

Summary

  • Companies seek mergers to gain access to a larger market and customer base, reduce competition, and achieve economies of scale.
  • There are different types of mergers that the companies can follow, depending on their objectives and strategies.
  • A merger is different from an acquisition. Mergers happen when two or more companies combine to form a new entity, whereas an acquisition is the takeover of a company by another company.

 

Why do Mergers Happen?

  • After the merger, companies will secure more resources and the scale of operations will increase.
  • Companies may undergo a merger to benefit their shareholders. The existing shareholders of the original organizations receive shares in the new company after the merger.
  • Companies may agree for a merger to enter new markets or diversify their offering of products and services, consequently increasing profits.
  • Mergers also take place when companies want to acquire assets that would take time to develop internally.
  • To lower the tax liability, a company generating substantial taxable income may look to merge with a company with significant tax loss carry forward.
  • A merger between companies will eliminate competition among them, thus reducing the advertising price of the products. In addition, the reduction in prices will benefit customers and eventually increase sales.
  • Mergers may result in better planning and utilization of financial resources.

 

Types of Merger

 

1. Congeneric/Product extension merger

Such mergers happen between companies operating in the same market. The merger results in the addition of a new product to the existing product line of one company. As a result of the union, companies can access a larger customer base and increase their market share.

 

2. Conglomerate merger

Conglomerate merger is a union of companies operating in unrelated activities. The union will take place only if it increases the wealth of the shareholders.

 

3. Market extension merger

Companies operating in different markets, but selling the same products, combine in order to access a larger market and larger customer base.

 

4. Horizontal merger

Companies operating in markets with fewer such businesses merge to gain a larger market. A horizontal merger is a type of consolidation of companies selling similar products or services. It results in the elimination of competition; hence, economies of scale can be achieved.

 

5. Vertical merger

A vertical merger occurs when companies operating in the same industry, but at different levels in the supply chain, merge. Such mergers happen to increase synergies, supply chain control, and efficiency.

 

Advantages of a Merger

 

1. Increases market share

When companies merge, the new company gains a larger market share and gets ahead in the competition.

 

2. Reduces the cost of operations

Companies can achieve economies of scale, such as bulk buying of raw materials, which can result in cost reductions. The investments on assets are now spread out over a larger output, which leads to technical economies.

 

3. Avoids replication

Some companies producing similar products may merge to avoid duplication and eliminate competition. It also results in reduced prices for the customers.

 

4. Expands business into new geographic areas

A company seeking to expand its business in a certain geographical area may merge with another similar company operating in the same area to get the business started.

 

5. Prevents closure of an unprofitable business

Mergers can save a company from going bankrupt and also save many jobs.

 

Disadvantages of a Merger

 

1. Raises prices of products or services

A merger results in reduced competition and a larger market share. Thus, the new company can gain a monopoly and increase the prices of its products or services.

 

2. Creates gaps in communication

The companies that have agreed to merge may have different cultures. It may result in a gap in communication and affect the performance of the employees.

 

3. Creates unemployment

In an aggressive merger, a company may opt to eliminate the underperforming assets of the other company. It may result in employees losing their jobs.

 

4. Prevents economies of scale

In cases where there is little in common between the companies, it may be difficult to gain synergies. Also, a bigger company may be unable to motivate employees and achieve the same degree of control. Thus, the new company may not be able to achieve economies of scale.

 

More Resources

CFI is the official provider of the global Certified Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful:

  • Due Diligence
  • M&A Considerations and Implications
  • Diseconomies of Scale
  • Types of Synergies

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