Module 2 — M&A: The Good and the Bad

Chapter 2.1

Why do companies opt for a Merger?

 

In simple terms, a merger happens when two existing companies voluntarily come together to form a single entity. Usually the companies that decide to merge are of equal size. One of the main reasons why companies opt for a merger is to gain/increase market share and expand into new areas.

Some of the other reasons why companies merge with other companies include:

  • Cost reduction: When two companies merge, it results in reduction of costs for the merged company. While the new company will have greater purchasing power, which in turn lowers the cost of acquiring raw materials, the budget for marketing and promotion purposes can be scaled down.
  • Growth: Mergers can give the acquiring company an opportunity to grow market share without having to really earn it by doing the work themselves - instead, they buy a competitor's business for a price.
  • More market penetration: By means of merger, the new company will have access to the customer base of the two individual, pre-merger companies, thereby facilitating more market penetration. However, this is true only if the individual companies were operating in separate markets.
  • Achieving economies of scale: A company is said to achieve economies of scale when it is able to reduce average cost with increased production/output. Lower average cost means that the company will be able to provide lower prices for its customers. A bigger firm will be able to get a discount for acquiring raw materials in bulk, which in turn reduces the average cost.
  • To create synergies: In the context of mergers, synergy is a state in which two companies work together in a way that produces an effect greater than the sum of their individual effects. By achieving synergy through merger, the company’s performance will increase and cost will decrease. a business will attempt to merge with another business that has complementary strengths and weaknesses.
  • Diversification: Merged companies offer a larger and wider range of products and/or services than the individual companies. The results will be even better if the individual companies provide complementary products/services. That way, the merged company will have an opportunity to conquer new markets.
  • Greater investment in Research and Development (R&D): In many of the industries such as Pharma, R&D plays a vital role. By way of merger, the company will have more profit and will be able to pool in greater funds for R&D.