3.2.3: Inorganic Growth

reasons for mergers and takeovers

• integration allows businesses to exploit synergies in a merger or takeover

  • arise from:

    • economies of scale

    • potential for asset stripping

    • reduction of risk through diversification

    • potential for gains by management

• quick and easy way to expand

• buying another business is cheaper than growing internally

• some businesses want to use available cash

• defensive reasons

  • consolidating position

  • avoids takeover if large

• response to economic changes

• merging in a different country allows companies to gain entry into foreign markets

• globalisation

• gains economies of scale

• asset strippers

  • firms buy a company, sell off profitable parts and close down unprofitable parts

• management may want to increase size

  • growth and size

distinction between mergers and takeovers

merger:

• 2 or more businesses join together and operate as one

• conducted with agreement of both businesses

• ‘friendly’

• new name formed from both old ones

• helps cut costs and cope with capacity and demand issues

takeover:

• acquisition

• one business buys another

• public limited companies - openly traded shares allows anyone to buy them (51%)

  • can result in a sudden increase in share price

    • investors buy shares

  • firms can takeover without buying majority shares:

    • shared ownership widely spread with little communication between shareholders

    • once a company has bought 3% of another company it must make a declaration to the stock market

• bought company loses identity and becomes part of the predator company

• private limited company - only bought if majority shareholders invite others to buy shares

horizontal and vertical integration

integration: businesses join together to form one

horizontal integration:

• occurs when two firms that are in exactly the same line of business and the same stage of production join together

• benefits:

  • common knowledge

  • less likelihood of failure

  • similar employee skills

  • less disruption

vertical integration:

• occurs when firms in different stages of production join together

• forward vertical integration - business joins with another that is in the next stage of production

  • removes profit margin expected by next firm

  • guarantees outlets for output

• backward vertical integration - business joins with another in the previous stage of production

  • guarantees and controls the supply of raw materials

  • removes suppliers profit margin

conglomerates

• a very large business organisation which owns a number of other businesses

• each business operates as a separate entity with its own board of directors

• each business is still under the control of the conglomerate

• group is usually acquired through mergers and takeovers

• advantages:

  • have a wide range of business interests

  • spreads risk of enterprise

  • large and powerful

  • group revenue and profit can support other businesses

  • exploit economies of scale

  • influence the market

• disadvantages:

  • diversification leads to difficulties

  • may become confusing

financial risks and rewards

financial rewards:

• stakeholder benefits - shareholders get immediate premium when taken over, higher future dividends, share price rises, improved job security, better remuneration packages

• stronger balance sheet - more assets = increased diversity, improved cash flow

• lower costs - exploit economies of scale

• lower taxes - can lower tax liabilities

financial risks:

• integration costs - complex, expensive, time consuming

• overpayment - overestimated financial benefits and underestimated cost of acquisition = inflated acquirer price

• bidding wars - businesses attract more than one buyer leading to the acquisition price rising

inorganic growth - advantages

• speedy growth - immediately enjoy benefits

• strategic benefits - activities complement each other, fills gaps

• economies of scale - benefits overnight, cost savings

• eliminate competition - fewer operators

inorganic growth - disadvantages

• regulatory intervention - attract attention of market regulators which can delay and cause delays if an investigation is launched, can block mergers or apply conditions

• drains resources - extremely costly

• culture clash - integration can be difficult, resistance to new cultures

• alienation of customers - may lose touch with customers, overlook needs, loss of customers

• loss of managerial control - additional layers of management delays communication, diseconomies of scale