Merger Meaning, Types, Advantages, Disadvantages
Table of Contents:-
Merger Meaning
A merger is an agreement that unites two separate companies to form a single, new entity for the growth of the organisation. Companies adopt this approach to boost their market share, realize economies of scale, and improve their overall competitiveness. A merger is a combination of two or more organizations in which they share resources, expertise and market access. This approach benefits a newly formed company, as it can leverage its strengths to achieve maximum success in the market.
A merger is a strategic move that combines two or more organisations. In this process, one company acquires the assets and liabilities of the other in exchange for shares or cash, or both companies are dissolved, the assets and liabilities are combined and new stock is issued. Other terms used for mergers are amalgamation, consolidation, or integration.
For the organisation, which acquires another organisation, it is an acquisition.
For an organisation, which is acquired, it is called a merger.
If both organisations dissolve their identities to create a new entity, it is known as consolidation.
What is Merger?
A merger is a combination of equals which is often pursued to achieve economies of scale, increase market share, and enhance competitiveness. Therefore, it is normal for a merged organisation board not to be dominated by the management of either of its predecessors. As a merger is necessarily an agreed transaction (by the Boards), this is anyway likely as Directors are not likely to agree to a merger that would deprive too many of the board of their jobs.
It is improbable that a merger will entail the payment of significant premiums to the shareholder of either predecessor company. This makes it less likely to destroy the value of shareholders. Like acquisitions, the synergies that provide the usual rationale for a merger may not happen, and integration is almost always difficult and costly.
Some mergers are initiated by directors to achieve sufficient scale to fend off potential takeovers by other directors. Mergers often require clearance from competition regulators. In some cases, they are blocked or only allowed subject to conditions (such as the sale of particular businesses).
Examples of Merger:-
There are several examples of mergers in the Indian corporate world, such as:
1) Polyolefin Industries with NOCIL,
2) TVS Whirlpool Ltd. with Whirlpool of India Ltd.,
3) Sandoz (India) Ltd. with Hindustan Ciba Geig Ltd.,
4) Nirma Detergents Ltd, with Nirma Soaps and Detergents Ltd., and
5) Detergents Ltd. with Nirma Ltd.
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Types of Merger
The different types of mergers are:
1) Horizontal Mergers
Horizontal mergers occur when there is a combination of two or more organisations in the same business, or of organisations engaged in certain aspects of the production or marketing processes. For example, a company manufacturing clothes combine with another clothing company, or a retailer of medicines combines with another retailer in the same business.
2) Vertical Mergers
Vertical mergers take place when there is a combination of two or more organisations, not necessarily in the same business, which creates complementarities, either in terms of the supply of materials (inputs) or marketing of goods and services (outputs). For example, a footwear-producing company combines with a leather tannery or a chain of shoe retail stores.
3) Concentric Mergers
Concentric mergers take place when there is a combination of two or more organisations which are related to each other either in terms of customer groups, customer functions, or the alternative technologies used. Thus, a footwear company combines with a hosiery firm making socks or another speciality footwear company, or with a leather goods company making handbags, purses, and so on.
4) Conglomerate Mergers
Conglomerate mergers take place when there is a combination of two or more organisations that are not related to each other, either in terms of customer groups, customer functions, or alternative technologies used, for example, a footwear company combining with a pharmaceutical firm.
5) Reverse Mergers
A reverse merger is also known as a back-door listing. It is a financial transaction that results in a privately-held company becoming a publicly-held company without going the traditional route of filing a prospectus and undertaking an initial public offering (IPO). Rather, it is accomplished by the shareholders of the private company selling all of their shares in the private company to the public company in exchange for shares of the public company.
The transaction is technically a takeover of a private company by a public company. It is also known as reverse takeover because the public company involved is typically a “shell” (also known as a “blank check company”, “capital pool company”, or “cash shell company”) and it generally issues such a large number of shares to acquire the private company that the former shareholders of the private company end up controlling the public company.
Advantages of Merger
The merger is found to be fruitful and leads to several benefits that can help the firm in serving its strategic aim. Some of the major advantages are given as follows:
1) Economies of Scale
Economies of scale occur when a larger company with increased output can reduce average costs. Different economies of scale include:
i) Technical Economies
If the firm has significant fixed costs, the new larger firm would have lower average costs.
ii) Bulk Buying
Discount for purchasing large quantities of raw materials.
iii) Financial
Better rate of interest for a large company.
iv) Organisational
Instead of two one head office is more efficient.
A vertical merger would have less potential economies of scale than a horizontal merger, eg, a vertical merger could not benefit from technical economies of scale.
2) International Competition
Mergers can help companies deal with the threat of multinational companies and compete on an international scale.
3) Mergers may allow greater investment in R&D
This is because the new company will have more profit. And this will lead to a better quality of goods for consumers.
4) Greater Efficiency
Redundancies can be removed if they can be employed more efficiently.
Disadvantages of Merger
The merger is adopted for expansion and many other strategic benefits, but some of the major disadvantages a firm can face after the merger are given as follows:
1) Integration Difficulties
It involves combining two disparate corporate cultures, linking different control and financial systems, building effective working relationships (particularly when management styles vary) and resolving issues concerning the status of the newly acquired firm’s executives.
2) Inadequate Evaluation of Target
Failing to conduct an effective due diligence process (thorough evaluation of the target company), can lead to the acquiring company paying an exorbitant premium (disproportionate to the performance gains).
3) Large Debt Burden
Firms are often encouraged to utilise significant leverage to finance large acquisitions. The large debt burden may put the company in a troublesome situation, especially when the returns are poor (e.g., India Cements’ acquisition of Raasi Cements, CCI, and Visaka Cements in quick succession increased its debt burden to over 1900 crores. It is now forced to sell all its prized acquisitions to stay in the business. It also prevents the company from investing in Research and Development activities.
4) Inability to Achieve Synergy
The acquisitions often fail to achieve the intended synergy because of many reasons such as managerial failures, non-cooperation from employees, scepticism, emotional doubts, etc.
5) Too much Diversification
Over- diversification may be counter-productive. The wave of mergers that followed in the 1980s did not bring any tangible benefits to the conglomerates. Excessive diversification forced many of these firms to divest the underperforming units after some time.
6) Too Large
Increased size has its inherent limitations. Achieving consistency in terms of actions and decisions may be difficult. Formalised rules and policies may come in the way of innovation and flexibility.
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