This article is authored by Akash Krishnan, a law student from ICFAI Law School, Hyderabad. It discusses in detail the different types of mergers, their advantages and disadvantages and case studies for each type of merger.
This article has been published by Sneha Mahawar.
Table of Contents
Introduction
Before delving into the different types of mergers, we must try and understand what are the reasons for which companies prefer mergers. This brings us to the principle of synergy, i.e., the principle that the whole is greater than the sum of the parts. In merger transactions, it is believed that when two entities come together and merge into a single entity, the net worth and profitability of the merged entity will be greater than the sum of both the entities pre-merger.
The primary goals of mergers are to increase the growth of the merged entity, enter new markets, maximise shareholder value and earnings per share, replace inefficient management with efficient managers, gain access to new products and technologies etc. Another key objective sought to be achieved by mergers is to gain economies of scale, i.e., to achieve the best possible/lowest cost of production. This occurs when entities in the manufacturing industry merge with entities engaging in the activity of supply of raw materials.
Theories of mergers
There are several theories that discuss the reasons behind mergers. Some of these theories have been enumerated below:
Efficiency theory
Mergers occur so that the merging entities can generate synergy and make mutual profits.
Monopoly theory
Mergers occur so that the entities can increase their market power and create a monopoly in their respective industry.
Disturbance theory
Mergers occur because of external disturbances like fall or rise in economy, loss due to natural disasters etc. The entities that remain unaffected by these factors merge with the affected entities to increase their market share.
Diversification theory
Mergers occur because entities want to diversify into different markets to avoid losses and for generating capital from different markets.
Strategic alignment theory
Mergers occur so that entities can adapt to changing technologies and business environments.
Now that we have understood the primary reasons behind mergers, let us move on to understand the different types of mergers.
Types of mergers
Conglomerate mergers
A conglomerate merger can be defined as a merger that occurs between entities that engage in totally unrelated business activities. Conglomerate mergers are further divided into two parts:
Pure conglomerate mergers
These mergers occur between entities that engage in completely unrelated business activities. For example, if a textile manufacturing company merges with a mobile phone manufacturing company, it would be deemed to be a pure conglomerate merger.
Mixed conglomerate mergers
These mergers occur between entities that engage in unrelated business activities but could be deemed as a market extension or product extension strategy of the merging entities. For example, if a mobile phone manufacturing company merges with a laptop manufacturing company, even though they are unrelated businesses, the intent of the merger is product and market expansion. Thus, it would be deemed to be a mixed conglomerate merger.
Advantages of conglomerate mergers
Diversification
Since the merged entity has business operations in different industries and different markets, they are free from industry-specific risks that may affect their investments and result in losses. Even if there is economic uncertainty in one industry, the merged entity can be assured that their entire business operation is not at risk.
Synergy
Once the two entities merge, they generate synergy and this results in an increase in the net value of the company.
Human capital
Experience is shared across the employees of the merged entities resulting in the generation of a positive workforce.
Cross-selling
The merged entities can cross-sell their products in the markets of each other using the existing supply and distribution channels thereby increasing the market share and reach of the merged entity.
Disadvantages of conglomerate mergers
Management costs
The merged entity will have a large workforce and therefore the cost of managing the workforce will increase substantially.
Tax advantage
As an individual entity, a company may receive certain tax benefits on the products it deals with because of the group structure of taxation. However, once the merger is completed, due to the variety of products falling under the same group, there will be a reduction in the tax advantages.
Cultural barriers
The culture of every organisation is different. The merger of two entities is also the merger of human values and diverse business expertise of the employees and the employees may face difficulties in adjusting to the work culture and values of each other.
The America Online-Time Warner merger
America Online (AOL) and Time Warner had announced their merger in January 2000. AOL was a leading company in the dial-up internet connection market. Time Warner on the other hand was a company that owned several media and publishing houses and had ownership rights over several movies and cable programs. Thus, it can be concluded that both these companies were engaged in completely unrelated businesses and the merger of these two companies was a conglomerate merger.
The intention behind the merger was that Time Warner would utilise the internet services of AOL and screen its content online. The expected synergy of the merger was $350 billion. However, post-merger, AOL could not keep up with the change in technology and soon the broadband connections which provided a higher speed and stability took over the internet world. Also, there were several cultural clashes between the employees of AOL and Time Warner. All these factors resulted in the failure of the merger and AOL that was valued at $226 billion at the time of the merger soon perished and its value came down to $20 billion.
Horizontal merger
A horizontal merger can be defined as a merger that occurs between entities that render the same products or services and thereby engage in business activities in the same industry. These mergers usually occur in industries having high competition. Higher competition results in firms looking for ways to increase their market share and generate maximum synergy. For example, Coca-Cola and PepsiCo are two companies that engage in business activities in the beverage industry and a merger between these two companies would be termed a horizontal merger.
Advantages of horizontal merger
Economies of scale
Since the same raw materials and machinery is used during the manufacturing process, a lower cost of manufacturing the product can be achieved.
Synergy
Once the two entities merge, they generate synergy and this results in an increase in the net value of the company.
Lower competition
Since the merging entities belong to the same industry, the individual competition of each merging entity is reduced post-merger.
Customer base
Since the merging entities cater to the same customer base and each customer has a preference for one product over the other, the merged entity will have an increased customer base.
Market share and profits
Due to the increased customer base of the merged entity and lower competition in the industry, the market share and profits of the merged entity automatically increase.
Disadvantages of horizontal mergers
Antitrust regulations
There are strict regulations in place in all countries that regulate unfair competition in the market. If a merger will result in the capture of a substantial amount of market share so as to create a monopoly in that industry, such a merger will not be allowed.
Cultural barriers
The culture of every organisation is different. The merger of two entities is also the merger of human values and diverse business expertise of the employees and the employees may face difficulties in adjusting to the work culture and values of each other.
Management issues
The large and versatile workforce of the merged entity could be difficult to manage. Also, there is a probability of a lack of coordination between the top and middle-level management for the implementation of new ideas or the launching of new products.
The Dow DuPont merger
Dow was a chemical company engaging in the business of agricultural sciences and performance materials and chemicals. DuPont also was a chemical company engaging in the business of agricultural sciences and performance materials and chemicals. They announced their merger in December 2015. Since both these companies engage in the same industry and are competing with each other in the same industry, the merger between the companies can be termed as a horizontal merger.
The intention behind the merger was to increase the net capital value of the company and cater to a larger customer base by increasing the market share. At the time of the merger, the merged company, i.e., DowDuPont had a combined net worth of $130 billion. Within 2 years of the merger, i.e., by 2017, DowDuPont had increased its net worth to over $150 billion. However, the company submitted for dissolution in 2019.
Vertical mergers
A vertical merger can be defined as a merger between two or more entities that form part of the same supply chain i.e., the entities are involved in different stages of production or different stages of distribution of the same product. It is pertinent to note that, unlike horizontal mergers where competition in the industry is one of the prominent reasons for the merger, in vertical mergers, the merging entities are not competing with each other but are only complementary to each other. For example, if an automobile manufacturing company merges with a company that engages in the manufacture of automobile engines it would be deemed to be a vertical merger because both companies are not competing with each other but are complementary to each other and form part of the same supply chain.
Vertical mergers are divided into two categories i.e., Forward vertical merger and Backward vertical merger. The distinction between the two categories have been enumerated below:
Forward vertical merger
This occurs when an upstream company merges with a downstream company on the supply chain i.e., a manufacturing company merges with a distributing company. For example, a company engaging in the production of milk merges with a company engaging in the business of supply and distribution of milk.
Backward vertical merger
This occurs when a downstream company merges with an upstream company on the supply chain i.e., a distributing company merges with a manufacturing company. For example, a company engaging in the distribution of mobile phones and laptops merges with a company engaging in the business of manufacturing mobile phones or laptops.
Advantages of vertical mergers
Economies of scale
Since the merger is between different entities in the same supply chain, the cost of production of the final good will be reduced and thus economies of scale can be achieved.
Technology
The involvement of different entities in the same supply chain can lead to the introduction of new technology that could be used to improve the quality of the end product.
Assurance
If a manufacturing company is merging with a company supplying raw materials, it can be assured of timely and continuous supplies and therefore can assure that the production of goods continues at a uniform speed.
Disadvantages of vertical mergers
Monopoly
Mergers in the same supply chain can result in entities having a monopoly over the price, quality and distribution of the manufactured goods.
Diseconomies of scale
In the merged entity, there could be a disparity in the profits generated by the supplier of raw materials and the manufacturer resulting in diseconomies of scale.
Discourages entry
New companies might find it difficult to enter into a market where there are vertical mergers because the new companies will not be able to compete with the reduced prices as offered by the merged entity.
The eBay-PayPal merger
eBay is a company that offers products for sale through an online platform. PayPal is a company that allows customers to perform online transactions. The merger between these two companies was announced in 2002. The intention of the merger was to introduce a user-friendly online payment system through which customers can pay for the products being purchased on eBay. It is pertinent to note that these two companies were neither operating in the same industry nor competing with each other. Accepting and processing payments was a part of the business of eBay and to facilitate the same it merged with a specialised entity that offered such services. Both these companies form part of the same supply chain and thus the merger can be termed as a vertical merger.
Market extension mergers
A market extension merger can be defined as a merger between two or more entities that render the same product or services but in different markets. For example, Tesla and Maruti Suzuki are two companies that engage in the business of automobiles but prominently operate in different markets i.e., USA and India. If these two companies merge together it would be deemed to be a market extension merger.
Advantages of market extension merger
Technology
Merging with entities in different markets will allow the companies to exchange and develop new technology and use the existing technology to modify their products and make them suitable for each other’s markets.
Market share and profits
Due to the increased customer base of the merged entity, the market share and profits of the merged entity automatically increase.
Synergy
Once the two entities merge, they generate synergy and this results in an increase in the net value of the company.
Customer base
Since the merging entities cater to the same customer base in different markets, the merged entity will cater to a large customer base in both markets and thus will have an increased customer base.
Disadvantages of market extension merger
Cultural barriers
The culture of every organisation is different. The merger of two entities is also the merger of human values and diverse business expertise of the employees and the employees may face difficulties in adjusting to the work culture and values of each other.
Management issues
The large and versatile workforce of the merged entity could be difficult to manage. Also, there is a probability of a lack of coordination between the top and middle-level management for the implementation of new ideas or the launching of new products.
Diseconomies of scale
In the merged entity, there could be a disparity in the profits generated in one market over the other resulting in diseconomies of scale.
The Eagle Bancshares – RBC Centura merger
Eagle Bancshares is a company engaged in providing financial services in the Northern American regions. RBC Centura is a company that provides financial services in Canada. These two companies merged in 2002. Since both companies are dealing in the same business activities but in different markets, the merger of these two companies can be termed as a Market extension merger. Post-merger, RBC Centura had the opportunity to introduce and grow its operations in the Northern American markets and Eagle Bancshares had set its footprint in the Canadian market.
Product extension merger
A product extension merger can be defined as a merger between two or more entities that render products or services in the same market that are either related to each other or are co-consumed together. For example, if a laptop manufacturing company merges with a company that manufactures laptop bags, it would be deemed to be a product extension merger.
Advantages of product extension merger
Market share and profits
Due to the increased customer base of the merged entity, the market share and profits of the merged entity automatically increase.
Synergy
Once the two entities merge, they generate synergy and this results in an increase in the net value of the company.
Customer base
Since the merging entities cater to the same customer base in the same market, the merged entity will cater to a large customer base in the market and thus will have an increased customer base.
Disadvantages of product extension merger
Cultural barriers
The culture of every organisation is different. The merger of two entities is also the merger of human values and diverse business expertise of the employees and the employees may face difficulties in adjusting to the work culture and values of each other.
Management issues
The large and versatile workforce of the merged entity could be difficult to manage. Also, there is a probability of a lack of coordination between the top and middle-level management for the implementation of new ideas or the launching of new products.
Diseconomies of scale
In the merged entity, there could be a disparity in the profits generated by one product over the other resulting in diseconomies of scale.
The PepsiCo – Pizza Hut merger
PepsiCo is a company that engages in the business of beverages and on the other hand Pizza Hut is an enterprise rendering service of food and food delivery. These two companies merged in 1977. The intention behind the merger was that both products should be co-consumed, i.e., at every Pizza Hut store, only the beverages manufactured by PepsiCo should be sold. Since consumers prefer to have a beverage along with pizzas, the objective behind the merger was achieved. It is pertinent to note that since the products sold by both the companies complement each other and are co-consumed, the merger can be termed as a Product extension merger.
Congeneric or Concentric merger
A congeneric merger can be defined as a merger wherein two or more entities are operating in the same market but are engaging in the business of different products or services that are complementary to each other. For example, if two companies operating in the financial services industry i.e., a bank and an insurance company merge, it would be deemed to be a congeneric merger because the products/services offered by a bank and insurance company are different yet complementary to one another.
Advantages of product extension merger
Customer base
Since the merging entities cater to a similar customer base in the same market, the merged entity will cater to a large customer in the market and thus will have an increased customer base.
Market share and profits
Due to the increased customer base of the merged entity, the market share and profits of the merged entity automatically increase.
Synergy
Once the two entities merge, they generate synergy and this results in an increase in the net value of the company.
Disadvantages of product extension merger
Cultural barriers
The culture of every organisation is different. The merger of two entities is also the merger of human values and diverse business expertise of the employees and the employees may face difficulties in adjusting to the work culture and values of each other.
Management issues
The large and versatile workforce of the merged entity could be difficult to manage. Also, there is a probability of a lack of coordination between the top and middle-level management for the implementation of new ideas or the launching of new products.
Diversification
Since both the merging entities engage in similar businesses, there is a threat as to diversification of the business to different sectors or different industries.
The Citicorp-Travellers Group merger
Citicorp is a company that provided banking services to its consumers and on the other hand Travellers group provided insurance and brokerage services. Both the companies were dealing with different products in the financial services industry. These two companies merged in 1998 to create Citigroup Inc. The intention of the merger was to combine the services being offered by these companies and cater to a large customer base in the financial services industry. Since both the companies were offering different products and services within the same market, the merger can be termed as a Congeneric merger.
Conclusion
The types of mergers discussed above have both advantages and disadvantages. A particular form of merger might not be suitable for a particular company. Therefore, the management should take utmost care while deciding which form of the merger they wish to undertake. Apart from deciding the type of merger, there are several other factors like due diligence, effect on shareholder value, earnings per share, synergy levels, cultural clashes etc. that need to be taken into consideration while making an informed decision.
The managers should compare both internal growth options like organic growth (expansion strategies, developing new products etc), inorganic growth (asset acquisitions) and external revenue growth opportunities like franchising, joint ventures etc to the growth being offered by a merger transaction so as to properly evaluate whether or not to go forward with a merger.
References
- 5 Types of Company Mergers.
- PEPSICO TO SPIN OFF RESTAURANTS
- Citicorp–Travelers Group Merger
- DowDuPont Merger Successfully Completed
- HISTORY’S Moment in Media: AOL Time Warner Merger
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