Part 1: Mergers and Acquisitions
In this article, we will look at the nature of Mergers & Acquisitions (M&A), different types of M&A and reasons behind each type of M & A. Competition concerns and assessment would be covered in detail in Part 2. M & A’s can be categorized according to the nature of merger.
Most mergers are simply done when one firm takeover another firm, but there are different strategic reasons behind this decision.
The purpose of a merger is usually to create a bigger entity, which accelerates growth and leads to economies of scale. However, a merger may lead to unwanted socio- economic implications that are often frowned upon.Compliance with competition law requirements represents a very important aspect of any M&A transaction. Mergers are governed under Restrictive Trade Practices, Section 72 of the Commerce Commission Decree 2010 (CCD2010).
Mergers vs. Acquisitions
Although these terms are often used as though they were identical, the terms merger and acquisition mean slightly different. A Merger is the combination of two similarly sized companies combined to form a new company. An Acquisition occurs when one company clearly purchases another and becomes the new owner.
M&As are a means to a long-term business strategy. New alliances, mergers or takeovers are usually based on company vision and mission statements, and reflect company corporate strategy in terms of what it wants to achieve with the strategic move in the industry.
Types of Mergers & Acquisition
- Horizontal Mergers:
Occurs when a company merges or takes over another company that offers the same or similar product lines and services to the final consumers, which means that it is in the same industry and at the same stage of production. Companies, in this case, are usually direct competitors. Some of the benefits of this merger include: increase in market share, revenues and profits, offers economies of scale due to increase in size as average cost declines due to higher production volume and encourages cost efficiency, since redundant and wasteful activities are removed from the operations.
- Vertical Mergers:
This is done with an aim to combine two companies that are in the same value chain of producing the same good and service, but the only difference is the stage of production at which they are operating. For example, if a clothing store takes over a textile factory, this would be termed as vertical merger, since the industry is same, i.e. clothing, but the stage of production is different: one firm is works in tertiary sector, while the other works in secondary sector. These kinds of merger are usually undertaken to secure supply of essential goods, avoid disruption in supply and also restrict supply to competitors, hence a greater market share.
iii. Concentric Mergers:
This takes place between firms that serve the same customers in a particular industry, but they donot offer the same products and services. Their products may be complements, product which goes together, but technically not the same products. For example, if a company that produces DVDs mergers with a company that produces DVD players; this would be termed as concentric merger.These kinds of mergers offer opportunities for businesses to venture into other areas of the industry reducing risk and provide access to resources and markets unavailable previously.
- Conglomerate Merger:
When two companies that operates in completely different industry, regardless of the stage of production, a merger between both companies is known as conglomerate merger. This is usually done to diversify into other industries, which helps reduce risks.
Reasons Behind Each Type of Mergers & Acquisitions
There are various reasons as to why a company might decide to merge or acquire another company, although there is a strategic reasoning behind the merger. Mergers and acquisitions usually create value for the company in different ways, some of which are listed below:
- Improve the company’s performance
This involves improving the performance of the target company, as well as the company itself. It is one of the most important reasons of value-creating strategies of M&A. If another company is taken over, its performance can be radically improved, due to economies of scale.
- Remove excess capacity
Companies merge with or acquire other companies in the industry, therefore getting rid of excess capacity in the industry. Factories and plants can be shutdown, since it is no longer profitable to sell at that low price. Usually least productive plants or factories are retired in order to bring the balance back to the industry. Reducing excess capacity has benefits as it extends less tangible forms of capacity in the industry.
- Accelerate growth
M&As are undertaken to increase the market share. If competitor company is taken over, its share of sales is also absorbed. As the result, the acquirer gets higher revenue and consequently higher profits. The acquirer also brings in its expertise and experience to bring efficiency to the operations of the target company. The combined company also benefits from exposure to various segments of the industry, which were previously unknown to the acquirer.
- Acquire skills and technology
Some companies control certain technologies exclusively, and it is too costly to develop these technologies from scratch. A merger/acquisition provides an opportunity for both companies to combine their technological progress and generate greater value from the sharing of knowledge and technology which usually leads to innovation.
- Roll-up strategies
Some firms are too small in the market and are highly fragmented, which means they experience higher costs, and it is not feasible for them to keep up operations because there are no economies of scale due to a very small volume.
- Encourage competitive behaviour
Many companies decide to take over other companies in an attempt to improve the overall competitive behaviour in the industry. This is done by eliminating price competition, which leads to improvement in rate of return of the industry. If the competition is kept at bay, and new entrants are not allowed, firms donot have to compromise on quality as price is no longer a competing factor. Smaller businesses can only gain share through offering at lower prices, but price competition reduces overall profits for the industry.
In order to restore the balance, mergers and acquisitions are initiated to improve the overall competitive environment in the industry.
Next Week: Mergers & Acquisitions [Part 2]
This is a weekly column compiled by the Fiji Commerce Commission in the hopes of raising awareness on what the FCC does so people can benefit from developing a better understanding,