3-2-2-mergers-and-takeovers

Reasons for mergers and takeovers

• Firms often grow organically to the point where they are in a financial position to integrate with others

• Merging with or taking over other businesses results in rapid business growth and is referred to as inorganic growth

  • A merger occurs when two or more companies combine to form a new company

    • The original companies cease to exist, and their assets and liabilities are transferred to the newly created entity

  • A takeover occurs when one company purchases another company, often against its will

    • The acquiring company buys a controlling stake in the target firm’s shares (more than 50%) and gains control of its operations 

Why firms integrate with others

• Strategic fit

  • A company may acquire another company to expand into new markets, diversify its product offerings or gain access to new technology

    • E.g. in 2010, Kraft Foods purchased Cadbury’s to increase its product offering and expand business sales in the UK

• Economies of scale

  • Growth creates economies of scale

    • Consolidation of two or more businesses typically reduces costs and increases efficiency

• Synergies

  • Synergies are the benefits that result from the combination of two or more companies, such as increased revenue, cost savings or improved product range

• Elimination of competition

  • Takeovers are often used to eliminate competition, and the acquiring company increases its market share

    • E.g. Meta, the parent company of Facebook, purchased WhatsApp in 2014, as it was a major competitor of its own Facebook Messenger

• Shareholder value

  • Mergers and takeovers can also be used to create value for shareholders

  • By combining companies, shareholders can benefit from increased profits, dividends and share prices

Types of integration

Horizontal integration

• A merger or takeover of a firm at the same stage of the production process

  • E.g. an ice cream manufacturer takes over another ice cream manufacturer

Evaluating horizontal integration

Vertical integration

• A merger or takeover of another firm in the supply chain or different stage of the production process

  • E.g. an ice cream manufacturer merges with a dairy farm

• Forward vertical integration involves a merger or takeover with a firm further forward in the supply chain

  • E.g. a dairy farmer merges with an ice cream manufacturer

• Backwards vertical integration involves a merger or takeover with a firm further backwards in the supply chain

  • E.g. an ice cream retailer takes over an ice cream manufacturer

Evaluating vertical integration

The financial risks and rewards of mergers and takeovers

• Inorganic growth carries both risks and rewards for a business

Financial risks and rewards of inorganic growth

Problems of rapid growth

• Inorganic growth often increases the size of the business significantly in a very short period of time

• This rapid growth can bring success, but if not managed well, it can lead to financial pressure, lower quality, unhappy customers and internal conflict

• Businesses must plan growth carefully to avoid these issues

Problems caused by rapid growth

1. Strain on cash flow

• Rapid growth often means higher spending before extra revenue comes in

• A business may need to:

  • Hire more staff

  • Invest in stock and equipment

  • Open new locations

• This puts pressure on cash flow

  • If the business doesn’t have enough working capital, it may struggle to pay suppliers or wages on time

2. Increased management complexities

• As a business grows, operations become harder to control

• Managers might:

  • Be given too many tasks

  • Lose track of team performance

  • Struggle to make decisions quickly

• This can lower productivity and delay key actions

  • E.g. a technology company that suddenly triples in size may find that decision-making slows down and projects are delayed

3. Quality control issues

• When a business expands quickly, its existing systems may not be able to cope

• This can lead to:

  • Mistakes in production

  • Poor-quality products

  • Inconsistent service

• E.g. a bakery that rushes to open new branches may find its cakes vary in quality between stores

4. Customer service issues

• With more customers and not enough trained staff, service levels can fall

• Problems might include:

  • Longer waiting times

  • Missed orders

  • Poor communication

• E.g. an online retailer experiencing a sudden surge in orders may send out the wrong products or delay responses to customer complaints

5. Culture clash

• If growth happens through mergers or takeovers, employees from different businesses may have different ways of working

• This can cause:

  • Disagreements

  • Lower morale

  • Poor teamwork

• E.g. if a relaxed, creative business merges with a more hierarchical, corporate one, staff may feel uncomfortable or confused about expectations

6. Diseconomies of scale

• When a business becomes too large, average costs can rise

• This is often due to:

  • Poor communication

  • Slow decision-making

  • Loss of motivation

• Detailed revision notes on diseconomies of scale are here