Why do companies merge

Why Do Companies Merge? Mergers and Acquisitions

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What industry do you think will be the next global consolidation?

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Corporations Merge for Many Reasons, but Not All Mergers Succeed

By Rosemary Peavler Updated June 22, 2016.

Mergers and acquisitions all have one underlying motive: to protect or improve the strength and/or profitability of the dominant company -- in other words, to maximize shareholder wealth. At least, that's the theory, which often applies. At other times, however, the motives may be less admirable -to protect a seated board of directors from a different merge that might put their jobs at risk or to squelch a stockholder reform initiative. When that happens, the outcome may be less fortunate. Not all mergers and acquisitions maximize shareholder wealth.In some instances, quite the opposite holds true. Below are some of the legitimate reasons a company may decide on a merger or acquisition.

Product and Investment Diversification Mergers sometimes happen because business firms want diversification -- a broader product offering, for example. If a large, conglomerate firm thinks that it has too much exposure to risk because it has too much of its business invested in one particular industry, it may buy a business in another industry.

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That would provide a measure of diversification for the acquiring firm. In other words, the acquiring firm no longer has all its eggs in one basket. In these instances, the underlying motive often is risk reduction. If a company

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Why Do Companies Merge? Mergers and Acquisitions

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with a strong product line of CD burners sees the market shifting toward What industryanother do you think will beactive the next digital downloads and streaming, it may acquire company in global consolidation? one of those market sectors.

Foreign Exchange and Foreign Market Acquisitions and Mergers Another kind of diversification attempts to reduce risk by merging with firms in other countries. This reduces foreign exchange risk and the dangers posed by localized recessions. Fiat, the originally-Italian multinational, merged with Chrysler Corporation, which made them more competitive in American markets while also reducing foreign exchange risk.

Acquisitions and Mergers to Improve Financial Position Improved financing is another motive for mergers and acquisitions. Larger business firms may have better access to sources of financing in the capital markets than smaller firms. The expansion that results because of merger may enable the recently enlarged firm to access debt and equity financing that had formerly been beyond its reach. Apple, for instance, one of the largest corporations in the world, has successfully issued about $60 billion in bonds, despite the fact that they already hold unprecedented amounts of capital. A smaller company, such as Dell, would be unlikely to succeed with a bond issue of this size. Since 2014, the successfully merged conglomerate, Fiat Chrysler, has been seeking another merger with a third corporate automobile giant to further increase their market share and capital base. If a company is in financial trouble, on the other hand, it may look for another company to acquire it. The alternative may be to go out of business or go into bankruptcy.

Tax and Operational Efficiency Advantages of Mergers and Acquisitions. There are several possible tax advantages associated with mergers and acquisitions, such as a tax loss carryforward. If one of the firms involved in the merger has previously sustained net losses, those losses can be offset against the profits of the firm that it has merged with, a significant benefit to the newly merged entity. This is only valuable if the financial forecasting for the acquiring firm indicates that there will be operating gains in the future that will make this tax shield worthwhile. Another, often-criticized corporate merger/acquisition scheme involves a company in a high corporate tax country merging with another corporation in a low corporate tax rate country. Sometimes the corporation in the low-tax environment is much smaller and would normally not be a candidate for a major corporate merger. With the merger, however, the new company is legally located in the low-tax country and subsequently avoids millions and sometimes billions in corporate taxes If two companies merge that are in the same general line of business and industry, then operating economies may result from a merger. Duplication of functions within each firm may be eliminated to the benefit of the combined firm. Functions such as accounting, purchasing, and marketing efforts immediately come to mind. This is sometimes particularly beneficial when two relatively small firms merge. Business functions are expensive for small business firms. The combined firm will be better able to afford the necessary activities of a going concern. But operating economies can be achiever by larger mergers and acquisitions as well.

Economies of Scale Economies of scale is an often employed way of increasing operational efficiency.The cost of doing business generally decreases, especially in manufacturing industries, when materials and other purchases are scaled up.

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Why Do Companies Merge? Mergers and Acquisitions

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Risks of Mergers and Acquisitions What industry do you think will be the next global consolidation?

Even when the CEO and the Board of Directors are honestly motivated to merge or acquire another corporation to improve the company's financial position in some way, things often do not work out as intended. Shortly after the massive merger of communications giants AOL and Time-Warner, AOL, the acquired company, posted an almost unimaginable $100 billion dollar loss, putting Time-Warner in financial jeopardy and leading to the problematic exits of top executives in both companies who were held responsible for the financial disaster. In some ways, the underlying cause was simply bad timing--the merger coincided with a growing dot-com financial meltdown. At other times, mergers fail because the corporate cultures of the two corporations are incompatible. At other times, mergers can achiever desired financial goals, yet operate against the public good, creating an anticompetitive monopoly.

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Definition and Characteristics

By Rosemary Peavler Updated June 21, 2016.

Types of Business Mergers Conglomerate mergers and congeneric mergers are two types of mergers with different characteristics from horizontal and vertical mergers. Horizontal mergers involve two Hero Images / Getty Images competitors merging. Vertical mergers involve a buyer and a seller merging. Both of these types of mergers involve companies that are somehow related combining their business operations. Congeneric mergers involve companies in related lines of business. Conglomerate mergers do not.

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Congeneric Mergers What industry do you think will be the next global consolidation?

Congeneric mergers are those where both companies involved in the merger are related by technology, markets, or production processes. The acquired firm in a congeneric merger is either an extension of a product line or a market related to the acquiring firm. A product extension merger happens when a new product line from an acquired firm is added to the existing product line of the acquiring firm. A market extension merger is when a new or closely-related market is added to the acquiring firm's existing markets through the acquired firm. CONTINUE READING BELOW OUR VIDEO

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Conglomerate Mergers Conglomerate mergers are mergers of two business firms engaged in unrelated business activities. The two firms are not two competitors merging as in horizontal mergers. They are also not a buyer and seller merging as in vertical mergers. They have no actual connection. In theory, the firms in a conglomerate merger have no overlapping factors, but in practice there is as aspect that they see as important that has drawn them together. They may see overlap in technologies, production, marketing, financial management, research and development or some other factor that makes them think they would be a good fit for each other. In fact, in conglomerate mergers, it only really makes sense from a shareholder wealth perspective for two companies to merge if there is a synergistic effect. Synergy is a concept you will often hear in business and, in particular, regarding mergers. Synergy can best be explained by saying it is the 2 + 2 = 5 effect. In other words, if two companies merge, the sum of the whole company should be greater than the sum of each part in order for the merger to make sense. If there isn't a synergistic effect between two merging companies, you have to wonder if the combination of the companies is a shareholder wealth maximizing activity. Why would two completely unrelated firms want to merge anyway? Even though this reason is never stated by the merging firms, it is often about market power. Some firms think, "The bigger, the better." Economists who are "anti-conglomerate" think that acquisitions of smaller firms by big conglomerates cause less efficiency in the financial markets. Along with market power, another reason one large firm may want to acquire another firm is to diversify its operations. If a large firm has just one line of business, it is very vulnerable to the ups and downs of the larger financial markets and the economy. If it introduces one or more new businesses in different areas under its "umbrella," it diversifies its product line and becomes less vulnerable to the whims of the market.

Consideration: The Problem with Market Power Firms that engage in horizontal mergers, as opposed to conglomerate firms, are more likely to merge to gain market power. Their mergers tend to

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consolidate industries. Take, for example, the banking industry. Banks that What industry do think other will bebanks. the next have merged since 1980 have moved horizontally to you acquire Inglobal consolidation? many cases, larger banks have acquired many smaller banks. The banking industry, since the Deregulation and Monetary Control Act of 1980, has become very consolidated. Regional banks and large national banks have essentially taken control of the banking industry. During the Great Recession of 2008, we saw the damage the big investment banks did to the economy. Just as bad as that, we saw how banks shut down credit to small businesses in the U.S. during and after the recession. This would not have been such a huge problem if the banking industry had not been so consolidated. They had the market power, however, to do this.

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