M&A: The Good and the Bad

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.

The relative success or failure of a merger depends on the criteria used to evaluate success and the timescale chosen to make the evaluation. It appears to be true that relatively few mergers create long-term shareholder value in their own right.

Some of the issues related to mergers are:

• Higher price: 

  While a merger allows companies to reduce competition, it can also give rise to monopoly in the market. The market goes into monopoly when there exist only a single manufacturer/supplier for a particular product and/or service. With reduced competition and high market share, the company can demand higher price from the customers. Even in the absence of monopoly, reduced competition more often than we think, leads to higher prices for the customers.

• Question of layoffs:

   When two companies merge, it often results in the reduction of labour force of the two companies. While this is one of the methods adopted by the company in order to save cost, it will have a negative impact on the employees. When they live in the constant fear of losing their job, it reduces employee motivation and results in reduced productivity.

• Clash of cultures: 

  The merging of two companies is more of a merger of the people associated with the companies than just the combination of two brands. Hence it is extremely important to ensure the compatibility of the culture prevailing in both organisations. If the two merging companies have different cultures and norms, then it can give rise to conflicts.

• Consumer attitude: 

  In the merger of two firms, it is important to consider the consumer attitude towards the individual companies and whether or not they perceive the two companies to be compatible. If the consumers don’t have the same perception about the individual companies, it will result in the merged company losing customer support.

• Diseconomies of scale: 

  When two companies decide to merge together, it is mainly to achieve economies of scale. A company is said to achieve economies of scale when it is able to reduce the average per-unit production cost with increased production. But at times, when two companies merge, being the bigger one will actually create dis-economies of scale since per-unit production cost increase due to increased coordination costs.

In an acquisition, a company buys more than 50% of or all of another company’s ownership to gain control over it. As part of the deal, the acquiring company buys the other company’s stock and assets.

The following are some of the reasons why a company opts to acquire another:

• High growth in minimum time:

   If a company want to achieve high growth in minimum time, acquisition is one of the best options. Through acquisition, the acquirer company can get hold of resources and core competencies which are not in the former’s possession. That way, the risks and cost related to new product development can be avoided.

• Gaining market share: 

  An acquisition will help a company get more market share, while reducing the threat from competition. If a company acquires its competitor, it reduces the competition’s stronghold and helps in obtaining synergy.

• Overcome the entry barrier: 

  Since a company is acquiring an existing company, the cost of entering the new market will be considerably low. Along that, the threat posed by competition is reduced as well as the acquirer can benefit from the acquired company’s existing client base.

• Gain resources and assets: 

  When a company acquires another, the acquirer gains the resources, experience of the employees, goodwill and the key assets of the other company. If the business acquired provides complementary products and/or services, it enhances the acquirer’s efficiency and productivity.

• Tax benefits: 

  Under certain instances, a company can enjoy taxi benefits if they acquire a less profitable company operating in the same industry.

When a company chooses the path of acquisition, the idea is to increase their revenues by acquiring a functioning company that will contribute to the income. However, acquisitions can present some difficulties and actually put the acquirer and the acquiree at a disadvantage.

Some issues that should be considered before pursuing an acquisition are:

• Increase in debt: 

  If a company has to borrow money in order to go ahead with acquisition, the debt so caused will be recorded on the books of the acquirer and they have to compensate for the debt from the revenues of the acquired company. In addition to this, the acquired company might also be having debt on its own, which get transferred to the acquirer.

• Conflict of ideas: 

  If the two individual companies have been working in different areas prior to the acquisition, they will be having ideologies and objectives of their own. If proper care is not taken to address these, it could escalate to a level where the difference begin to affect the day to day activities.

• Layoff of employees: 

  More often than not, an acquisition results in a company with employees who replicate one another’s work. In order to avoid paying more employees than needed, for doing the same job, management opts for laying off the redundant employees. This reduces employee motivation as they live in constant fear of losing their job, which in turn affect the productivity of the company.

• Conflict of work culture: 

  Every company has its own identity and the work culture developed by the company plays a huge role in making this identity. If there is no compatibility between the cultures of the two companies involved in the acquisition, it gives rise to conflicts, right from the employee level.

• Saturated market and unrelated diversification: 

  If a company is to acquire another in the same industry, then the scope for market expansion is low, since both companies together might be enjoying majority of the market. On the contrary, if a company aims for diversification and acquires a company in a different industry, there could be difficulties in managing the resources and capabilities as everything is new to the acquirer company.

Mergers and acquisitions both involve the combination of existing companies into a new larger entity. In the case of a merger, both organizations negotiate around the terms and conditions of the merger and seek shareholder support. Mergers therefore tend to be more amicable. In an acquisition one company buys another company. In some cases, there may be no negotiation or prior approval. A company might therefore consider a merger where it needs to acquire new or complementary skills or resources but does not necessarily want to buy another company. One obvious reason for this might be the cost of the target company. The nature of the merger could take several forms. In most cases of a merger of equals, both companies must be prepared to make significant organizational changes and variations in working practices. If a company is not prepared to do this, a simple acquisition might be a more favourable option.

1. For businesses, merger is an attractive option because it enables them to reduce the cost of operation, accelerate the growth, penetrate the market with more ease and last, but not the least, create synergies.

2. Acquisition is a good option for a company that aims to achieve high growth in minimum time.

3. While mergers and acquisitions provide business with immense opportunities, they also create certain issues in terms of people management, clashing work cultures and increased debt.

4. A merger happens when a company is looking to obtain skills and resources but not necessarily by buying another company whereas an acquisition is where one company buys another company.