Merger Activity

Merger Activity

"In today's global business environment, companies have to grow to survive, and one of the best ways to grow is by merging with another company" (washingtonpost.com, 24.03.2008 )

A merger occurs when one firm assumes all assets and liabilities of another. The acquiring firm retains its identity, while the acquired firm ceases to exist. In the later half of the twentieth century it became vital for a company to grow if it were to remain in such a competitive marketplace. At this time, mergers and acquisitions became two of the more common methods to achieve the expansion and growth they required in order to survive. There are three main strategies of merger activity in which a firm can adopt, these are; horizontal, vertical and conglomerate. The chosen strategy is dependent upon factors such as the competitive relationship between the merging parties and the financial position at the desired time of growth or integration. Merging is usually performed in the hopes of realising an economic gain. For such a transaction to be justified, the two firms involved must be worth more together than they were apart.

Overall, the potential advantages of mergers include; achieving economies of scale, combining complementary resources, garnering tax advantages and eliminating inefficiencies. Other reasons for considering growth through merging include obtaining proprietary rights to products or services, increasing market power by purchasing competitors, shoring up weaknesses in key business areas, penetrating new geographic regions or providing managers with new opportunities for career growth and advancement.

Merger activity comes in waves of low and feverish activity which tend to correspond with periods when the stock market is buoyant with rapidly rising share prices and when, therefore, the finance of mergers is easy to carry out. These periods also tend to correspond to periods of rapid growth in the economy, when business confidence is high.

In a horizontal merger, one firm acquires another firm that produces and sells an identical or similar product in the same geographic area and thereby eliminates competition between the two firms. This form of merging was a common occurrence in the 1960’s and accounted for the majority of mergers across the UK. Although the overall number of mergers has decreased significantly from its peak in the late 1980’s, horizontal integration still accounts for 80% of the total number of mergers. Horizontal integration allows for various economies at both plant level and firm level. For example, production may be concentrated into a smaller number of large production premises. This in turn will lead to a reduction in the cost per unit as the output capabilities of the plant will be increased. Firm economies result from the expansion of the entire company, allow economies through bulk buying and cheaper cost of finance etc.

Using horizontal integration allows a company to reach a wide audience without having to diversify into new products. A good example of this is GAP Inc. This company is in charge of and runs four separate companies; Forth & Towne (boutique clothing), Banana Republic (up-market clothing), Old Navy (children's clothing) and GAP (general clothing). Each company produces and sells clothing, but targeted at different markets. It allows GAP Inc to reach a wide audience without having to diversify into new products. The benefits of being in control of four smaller companies is that GAP Inc does not have to create a new image for itself in order to reach its wider audience as the customer base was already there before the merger took place.

Vertical mergers take two basic forms: forward integration, by which a firm buys a customer, and backward integration, by which a firm acquires a supplier. The benefits of this type of integration include closer control over the finished product and lowering factor input costs. This type of merger accounts for a very small number of mergers due to monopoly legislation. Companies taking part in vertical integration gain increased market control which can result in the formation of a monopoly.

One of the biggest and earliest examples of vertical integration was the Carnegie Steel Company. The company controlled the mills where the steel was manufactured, the iron mines where the raw material for the steel was extracted, the coal mines that supplied the coal for fuel, the ships that transported the iron ore as well as the rail transport that was used to take the iron ore to the factories. This example shows just how easy it is for monopolies to form with vertical integration. At the time, any company trying to compete with the Carnegie Steel Company would fail, which is why such strict legislation is now in place.

Despite this, there are many