Paragraph on Increase market power
Along with the idea that two firms together are worth more than the value of the firms apart, one of the most important forces driving mergers is the attempt to increase market power. Through horizontal mergers especially, a firm can gain a larger market share and enhance market power, with ability to exercise some control over the price of the product or service.
This could enables the firm to charge lower prices if the costs are reduced, to increase barriers to entry or to increase sales, thus making it harder for smaller to competitors with higher costs to compete, whilst deterring others from entering the market who are also likely to start off with higher costs. The firm could also push prices up because customers have few alternative sources of supply.
Also, collusion between firms in a concentrated market, whether openly or not, is made easier and can sometimes take place, as it did in the cement, steel and chemical industries, before the regulatory authorities fined a number of firms for such socially damaging practices. 2001 saw the Competition Commission block General Electric’s bid for Honeywell because it believed it was attempting to put competitors at a disadvantage. Even conglomerate mergers can increase market power through, for example, insisting that customers buy products from one division if they want products from another.
There are also a number of other synergistic benefits resulting from mergers such as the internalisation of transactions whereby bringing together two firms at different stages of the production chain may help the acquirer achieve more efficient co-ordination of the different levels. Possible entry to new markets and industries through the purchase of an existing player in that product or geographical market is another aspect of synergy, as is the possibility of a reduced taxable profit in countries such as the U. S. A.
Another part of synergy, which is the one of the primary reasons advanced for conglomerate mergers is that of risk diversification. This is the idea that the overall income stream of the holding company will be less volatile if the cash flows come from a wide variety of products and markets. However there are problems this argument, as Glen Arnold says; “the investors can obtain the same risk reduction in a easier and cheaper way by buying a range of shares in the independent separately quoted firms. ” (Corporate Managerial Finance, P.877)
Apart from these synergistic origins, which are the potential gains available through the combining of the two firms trading operations, there are other factors that organisations should take into consideration prior to an acquisition, such as the possibility of ulterior managerial motives being prominent. Financial economists like to think that business decisions are based only on economic considerations, especially maximisation of firms’ values, and in a mergers case, shareholder wealth maximisation.
However, many business decisions are based more on managers’ personal motivations than on economic analysis, and mergers are no exception. There are usually a number of benefits for the management team of an acquiring firm after merger activity. They are likely to receive a higher wage because they have responsibility for a larger business. And a larger wage would normally mean enhanced pension contributions and other perks. Being on a higher wage and being in charge of more people also brings higher status, and some believe managers simply enjoy the excitement of the merger process itself.
Personal considerations can deter as well as motivate merger activity. For the managers of the acquired companies, mergers can often lead to them losing their jobs, or at least their autonomy. Therefore, some managers who own less than half of their firms’ stock look to lessen the chances of a take-over, this can result in defensive mergers taking place, not for economic reasons but for managerial ones. For example, when Enron was under attack, it arranged to buy Houston Natural Gas, paying for it primarily with debt.
This merger made Enron much larger, and the much higher debt level made it harder for any potential inquirer to use debt to buy Enron. Organisations also have to consider how they are going to finance the merger. Over the last thirty years, the most popular method of paying for the purchase of shares in another company is by cash, but payment by debentures, loan stocks, convertibles and especially by shares has also been prominent at times.
As firms look to quicken growth by acquiring existing companies, combine to ward off competitors and secure their survival in industries that are declining, whilst having to compete on an increasingly global scale, mergers are almost inevitable. Whether it is for economic benefits or managerial benefits, there are a lot of factors that an organisation should consider prior to an acquisition. And as expenditure on merger activity goes up and up, it is vital for the success of any merger that none of these factors are overlooked.