Tuesday, February 16, 2016

Broad categories of mergers


The three broad categories of mergers and acquisitions are:

 

1.     Horizontal merger/acquisition

2.     Vertical merger/acquisition

3.     Conglomerate merger/acquisition

 

1.     Horizontal merger/acquisition:

 

This happens between two companies or businesses placed in the same market and providing the same products or services. An example of a horizontal merger/acquisition is the Mobilink-Warid merger/acquisition. The motives of companies entering into a horizontal integration are any or all of the following:

 

a.     Economies of scale:  By joining together and forming a bigger company gives the new entity or the expanded entity greater economies of scale. These are the cost advantages that companies obtain due to size, output, or scale of operations such as production etc.

 

b.    Synergies: By combining sales channels for example, companies can increase their outreach and become a larger player.

 

c.     Market share and growth: Horizontal mergers are one way of improving market share. Similarly the businesses merging may conclude that together they can grow better and because of a better market share will be in a stronger position to influence the market.

 

d.    Eliminating redundancies: Two companies would have two finance departments, two legal departments, two procurement departments etc. Mergers and acquisitions can help eliminate redundancies. Obviously this is bad news for the employees but overall by eliminating redundancies, companies become more profitable.

 

e.     Filling the product range/product line: In some cases an acquisition of this kind can help fill a product range. So for example in Mobilink-Warid merger/acquisition, the attraction for Mobilink is the 4G LTE spectrum which it does not have on its own. Mobilink would be able to provide 4G LTE services to its users ultimately without having paid excessive amounts for 4G unlike ZONG for example which has paid a large amount for its 4G spectrum.

 

 

2.     Vertical merger/acquisition:

 

Vertical mergers/acquisitions happen between two companies which – while in the same industry- are in a buyer-seller relationship.  Backward vertical integration would be a company merging with or acquiring its supplier. Forward vertical integration would be a company taking over a retailer, wholesaler or distributor. The main reason for a vertical integration is to ensure either that the supply lines are reliable, or to ensure greater control over distribution networks and sales channels. A famous example of this kind of merger is the one that occurred between Time Warner and AOL in 2000.  Time Warner creates content and AOL was the largest internet dissemination portal at the time. Eliminating redundancies also occurs to a certain extent in this kind of merger. Similarly it may be useful in order to deploy certain capacities which previously were not available. This is what happened with British Petroleum’s 2003 acquisition of Russian TNK company which had oil reserves but little refining ability or retail marketing for the western market.  BP took over TNK and it was a win win for both sides because BP got access to oil reserves which it could then utilize in its refineries and sell through its sales channels.

 

 

 

3.     Conglomerate merger/acquisition:

 

The conglomerate merger/acquisition usually happens between two unrelated companies. A great example of this kind of merger was Phillip Morris’ 1985 acquisition of General Foods i.e. a tobacco giant taking over a diversified food company. Another example was the 1959 acquisition of Avis, Sheraton Group and Continental Baking Company by International Telephone and Telegraph Corporation – which were completely unrelated. The reasons for this sort of merger/acquisition are as under:

 

a.     Breaking through cyclical and seasonal demand: By far the greatest reason for a buyer acquiring an unrelated business is diversification, especially when its own product is of a cyclical or seasonal nature. By breaking into a new market, it ensures that it is constrained by a particular season or a particular kind of demand.

 

b.     Regulatory pressures:  Regulatory pressures in one industry might force a buyer to look for alternatives in a market or industry that is not as heavily regulated. This is a very common reason for conglomerate merger/acquisition.

 

 

A slight variation on this kind of merger is a concentric or congeneric merger. In this case the two companies are in the same industry but serve different subsets or markets within it.  A merger between a WLL broadband company with a cellular mobile company would be an example of this congeneric or concentric merger. Similarly one may argue that Microsoft’s acquisition of Nokia (to enter into the smart phone market) was this kind of acquisition though it has turned out to be a colossal failure.

 

c.     Product line extension/market extension: Extension of product line or market extension – as mentioned above- may be the rationale for a congeneric or concentric merger.  Here too a product line hole may be filled by acquiring a company that has the requisite product or intellectual property. Google and Yahoo’s acquisitions of online app companies are great examples of such mergers/acquisitions. Proctor and Gamble’s 2005 acquisition of Gillette for men care products was done to fill a hole in its product line.

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