3.1.3 Demergers

Spec:

a) Reasons for demergers b) Impact of demergers on businesses, workers and consumers

What is a demerger? A demerger is when a large firm is separated into multiple smaller firms. For example, if Boots sold Halfords since it did not match their main activities.

Reasons:

  • Cultural differences – Differences within the two businesses cultures can cause demergers to occur. This is due to the fact that culture is the main aspect of how a business operates and therefore if the merged businesses cultures are incompatible with one another it can cause inefficiency and lack of integration. Therefore, it may be better for the business to demerge in order to improve business operations.

  • Reducing the risk of diseconomies of scale – By demerging it can reduce the risk of becoming too big too fast and therefore the negative aspects that are associated with this. For example, demerging can reduce the levels of the business hierarchy, thus making communication faster. As a result of this, efficiency within the business is likely to increase, reducing the business’s costs.

  • Increased focus – Mergers can often result in the business losing focus of its key aims and objectives. This is especially the case for conglomerate mergers, as it takes some of the business’s focus away from the market they’re in and shifts it towards a new one. Although this may be good for the business in terms of diversification, it can make it harder to become dominant in one market, as they are now shifting some of their resources towards a completely different market. This can also help cut AC and improve profit margins & return to shareholders

  • Remove loss making parts – A business may decide to demerge if some areas of the business are making much more profit than another part of the business which may be loss making. For example, after a conglomerate merger the business in the technological industry may be doing

  • Defensive tactic - Regarding game theory to avoid the attention of competition authorities who might be investigation monopoly power

Topical examples of business demergers

  • Pfizer selling their infant nutrition business to Nestle.

  • Severn Trent Water demerged the waste management firm Biffa.

  • PayPal splitting from eBay in 2014.

  • Costa Coffee sold by Whit bread to Coca Cola

Impacts on employees:

  • Job Certainty - Employees may experience certainty about their job security, roles and responsibilities following a demerger. Some positions might be duplicated or simply no longer needed leading to layoffs

  • Changes in compensation and benefits - Compensation packages include salaries, bonuses and benefits which may be different with new entities

  • Opportunities and growth - While demergers can bring problmes they can also bring new opportunities for growth end employees to take on new roles, develop new skills and contribute to the growth of newly dependent companies

Impact on consumers:

  • Disruption of services - There is a potential for disruption of services or products during demergers as systems and operations are divided between entities. Customers might experience delays or changes in services

  • Choices and competition - This can lead to increased competition between entities which can lead to lower prices and higher quality

  • Contractual changes - If customers have ongoing contracts with demerged companies the terms and condition may change and become less favourable

Impact on businesses:

  • Firms can dispose of underperforming or loss-making parts of the firm. It allows the larger firm and the new, demerged firm to focus on their core activities. This allows them to adapt to their unique markets, whereas in a large firm, managers could find it hard to focus on each market.

  • Firms might be able to eliminate diseconomies of scale, since they are better able to control and coordinate their business.

  • The firm could make a profit by selling off a part of the firm. This can also be used as a source of finance, which will allow them to invest in other parts of the firm

Impact on shareholders:

  • Stock prices change - Following demergers stock prices may fluctuate in response to adjusting on their own

  • Dividend policies - Dividend policies from newly formed entities may be different

  • Portfolio diversification - Shareholders who held shares in diversified companies prior might have multiple shares in more entities

  • Strategic focus - The demergered companies might have clearer strategic focus allowing investors to align their portfolios with companies that match their investment preferences