Expansion through acquisition and merger
...tinction between acquisition and merger is not so clear. It will be difficult to determine when we use the words ‘acquisition’ or ‘merger’. So we can analyze them together and call them A&M. Three broad categories of acquisition and merger are identified: * Horizontal integration * Vertical integration * Diversification 2. Motivation for Acquisitions and Merger Most people think that the motivation to acquire or merger is to achieve maximize profits. Although it is not exact enough, the expectation of higher profits is an important factor in the process of acquisition and merger. The motivation should conclude: Market Power Acquiring firm can increase the market power through acquisitions and merger in order to exclude rival firms from market, excise more power over pricing policy or the quantity of production supplied to the market, and can protect the market position achieved by acquisition or merger. Market power is also a means of protecting innovation developed by the firm. Innovation is likely to arise and achieve higher profits. So firm can acquire or merger to continue to innovate and protect them from the threat of acquisitions by other big companies. Horizontal Integration and Market Power: a. Entrepreneurial motivation Penrose’s theory of the growth of firm suggests that entrepreneurial management will seize any growth opportunity. That means active entrepreneurial management will achieve increased long run profits by increasing market share, it may be to increase the market power. b. Decline in market demand When there is a decline in market demand, excess capacity will be left. It will cause price-cutting competition. All similar rival firms may try to increase their market share. In this situation, acquisitions or merger may be the quickest and most safe way to reduce operating costs and increase market share. c. International competition In order to meet the large efficient international competitors and protect domestic market, domestic firms may be to acquire and merger. This is also a method to increase market power. d. Competition legislation If there are restrictive agreements between firms caused by a tightening in the laws controlling competitive practices, firms may use horizontal acquisition or merger to seize growth opportunity and own more market power to exclude rival firms. Vertical Integration and Market Power Vertical integration can give firms chance to exercise market power to increase profits by 2 means: a. Backward integration: by monopoly controlling over a scarce raw material, it will be more expensive for rival firms to enter into the market. So firms can exclude rival firms from market and protect their market position. b. Forward integration: by creating a monopoly of distribution of products, firm can force the rival firm to enter into the market but have to accept a lower price for sale and distribution. Diversification and Market Power It is not obvious that diversification into new market increase market power. But the large diversified firms have enough financial resources and they can exercise their market power to reduce the cost of its product, to increase the influence of the products and to expand its market share in order to eliminate smaller rivals and set a barrier to new entrants to the market. Economies of Scale Economies of scale can be generated at 2 levels: Plant level The economics of scale at this level can be called technical, if it arises from increased scale of production, the ability to specialize both machinery and labor process, and the use of new technology to the production. Firm level The economics of scale at this level arise from the increased size of the firm, its ability to perfect operational structure in order to achieve its aims effectively, and increase the firm’s ability to exercise market power. Acquisitions or merger always be used to reduce average cost by increasing the size of firm and the scale of its operations. For instance: Vertical Integration and Cost Reduction If there are 2 independent and technical stages in the production process, the vertical integration of 2 stages may reduce the cost of production. A firm, which specializes in producing a product and selling this product to many firms at the succeeding stage, may increase its scale of production. The effect of cost-reducing activity may increase the firm’s profits. Diversification and Cost Reduction If one product create excess resources which can be used in the production of another product, the resources is shareable between the products If shareable resources exist, so that economies of scope exist, then the cost of joint production (e.g. mutton and wool) will be much lower than for separate production. Through the type of diversification of merger and acquisitions, the firm can reduce cost and achieve higher profits. Speed and safety factors Even when internal growth is feasible, merger of acquisitions is a quicker and a safer way of growing. Time is very important in the growth of firm, because the opportunities will not always exist. A firm is on the verge of bankruptcy, if they want to expand internally, they must overcome many difficulties such as, patent protection, or need to acquire new production and marketing skills, and then the time needed for internal expansion may be too long. The rapid acquisitions or merger may be necessary, the problems will be often be solved more quickly by acquiring or combination with an existing firm to use its patents, brand names and so no. Diversification and risk spreading ‘ Not putting all your eggs in one basket’ Through diversification, the security, which managers ask for, will be protected. The risk spreading can also encourage those who finance the firm or have excess capacity to invest more in a diversified firm than they would to a specialized firm. Firms may benefit from spreading risk. The safety motive can clearly be translated into the relative profits. The market for corporate control Acquisition and merger activity may be a sign of an active market for corporate control, which ensures that assets are managed efficiently. In order to control assets, competition between rival management takes place. If a firm cannot manage assets efficiently, they will achieve lower profits than rivals. And then, they are likely to be acquired by other rival firms whose management makes more efficient use of th...