Company Company Company

A B C

Increase in share value Cost efficiency

of a firm

Share
Market
Holders'
Benefit
Benefit

Company's Employee's
Benefit Benefit
Increase in production Iron out the internal
differentiation to maintain
satisfaction
Introduction

Along with globalization, merger and acquisition has become not only a method of external
corporate growth, but also a strategic choice of the firm enabling further strengthening of
core competence. The megamergers in the last decades have also brought about structural
changes in some industries and attracted international attention. Several motivations for
merger and acquisition are proposed in the literature, mostly drawn directly from finance
theory but with some inconsistencies. Interestingly, distressed firms are found to be predators
and the market reaction to these is not always predictable. Several financing options are
associated with takeover activity and are generally specific to the acquiring firm. Given the
interest in the academic and business literature, merger and acquisition will continue to be an
interesting but challenging strategy in the search for expanding corporate influence and
profitability.

Definition: A merger is the combination of two companies into one where one is being
absorbed by the other. In other words, when two or more companies are consolidated into one
company.

In Finance, Merger is an act or process of purchasing equity shares (ownership shares) of one
or more companies by a single existing company.

Examples of merger
Acquisition

In an acquisition one business buys a second and generally smaller company which may be
absorbed into the parent organization or run as a subsidiary. In an acquisition, a company
takes at least 50% ownership of another company, and takes controls over it. The company
under consideration by another organization for an acquisition is sometimes referred to as the
target. As part of the exchange, the acquiring company often purchases the target company's
stock and other assets, which allows the acquiring company to make decisions regarding the
newly acquired assets without the approval of the target company’s shareholders.
Acquisitions can be paid for in cash, in the acquiring company's stock or a combination of
both.

Types of Merger

Horizontal Merger

A horizontal merger is when two companies who sell the same product or cater to the same
demographic come together to increase their reach. Typically, this type of merger is done
between direct competitors. As competition tends to be higher and the synergies and potential
gains in market share are much greater for merging firms in such an industry.

This type of merger must happen between two companies with similar products, customers,
and target market.

Examples of horizontal merger: Reebok and Adidas, the second and third largest sports shoes
makers merged in order to cut production and distribution costs by combining their
operations. Another example would be the merge between Confinity and X.com to become
Paypal.

Vertical Merger

Unlike horizontal mergers, vertical ones aim to capture more of the means of production than
expanding their market cap by merging with competitors or innovators in their niche. A
vertical merger occurs when two or more firms, operating at different levels within an
industry's supply chain, merge operations. Most often, the logic behind the merger is to
increase synergies created by merging firms that would be more efficient operating as one.

Basically, a vertical merger is when one company merges with a company that is better at one
step of their process.

One example is when Shell Oil which owned more oil and gas refineries, joined with Texaco,
which owned more gas refueling stations.

An automobile company joining with a parts supplier would be an example of a vertical

merger. Such a deal would allow the automobile division to obtain better pricing on parts and
have better control over the manufacturing process. The parts division, in turn, would be
guaranteed a steady stream of business.
Advantages:

1. Network Economies: In some industries, firms need to provide a national network.

This means there are very significant economies of scale. A national network may
imply the most efficient number of firms in the industry is one.

2. Research and Development: In some industries, it is important to invest in research

and development to discover new products / technology. A merger enables the firm to
be more profitable and have greater funds for research and development.

3. Other Economies of Scale: The main advantage of mergers is all the potential
economies of scale that can arise. In a horizontal merger, this could be quite
extensive, especially if there are high fixed costs in the industry.

4. Avoid Duplication: In some industries it makes sense to have a merger to avoid

duplication. Avoiding duplication would have environmental benefits and help reduce
congestion.

5. Regulation of Monopoly: Even if a firm gains monopoly power from a merger, it

doesn’t have to lead to higher prices if it is sufficiently regulated by the government,
which will help firms to benefit from economies of scale, but consumer won’t face
monopoly prices.

 Disadvantages:

1. Higher Prices: A merger can reduce competition and give the new firm monopoly
power. With less competition and greater market share, the new firm can usually
increase prices for consumers.

2. Less Choice: A merger can lead to less choice for consumers.

3. Job Losses: A merger can lead to job losses. This is a particular cause for concern if it
is an aggressive takeover by an ‘asset stripping’ company (a firm which seeks to
merge and get rid of under-performing sectors of the target firm).

4. Diseconomics of Scale: The new firm may experience dis-economies of scale from

the increased size. After a merger, the new bigger firm may lack the same degree of
control and struggle to motivate workers. If workers feel they are just part of a big
multinational they may be less motivated to try hard.