Abstract
The study is conducted to discuss the potential benefits and cost to the companies involved in the horizontal mergers. Based on the evidences of profitable and unprofitable mergers, it is also aimed to explain the phenomenon of the mergers tend not to increase the profit of the companies. The mergers are the combination of two companies negotiated with each other to form a single large corporate. Though, the discussion of the study suggested that the companies are needed to analyze various internal as well as external factors such as market competition, national culture, market conditions, and economic conditions to predict and analyze the merger situation and to use the proper ability to reduce the negative impacts of these factors.
The study also suggested that the profitability of the merger is not fixed as in various situations, the mergers can be developed as Unprofitable mergers or either changed into unprofitable. To support the arguments, the case of merger of Sprint and Nextel as well of Nestle and Perrier is discussed to support the arguments.
Introduction
Mergers are included in the top issues of the financial world of the corporate (Hoang & Lapumnuaypon, 2008). The combination of the two companies to form the large organization is known as mergers. The companies usually act on mergers to compete in the competitive market and improve their efficiency and performance. The deals between the firms are made, can be worth of millions and billions in mergers. The way in which the mergers are formed and the companies combined makes them different from the acquisition (DePamphilis, 2010). Since, the merger wave has flown in the business world; the debate has been continued about the benefits of merger, its impacts and the environmental factors to be considered developing mergers. Therefore, the study is going to analyze the arguments and discuss the potential benefits of the merger with the help of analyzing the real world situations.
Mergers and the aspects of Environment
Merger can be defined as the combination of two or more companies to develop a large business or corporation (Evans, 2000). Apart of mergers, horizontal mergers are those mergers that have developed between the two companies in the similar or common industry. In mergers, the companies usually negotiate prior their combination will take place. The two companies, when consider the benefit of their combination in the market, they discuss with each other considering the challenges and complications as well as the potential benefits. If the two companies found the favorable conditions, their negotiation would results in the merger to form a new large organization (Bruner, 2004).
Based on these favorable conditions, the companies are required to focus on multiple aspects and the factors from the environment while analyzing the situation of the mergers. Farrell and Shapiro (1990) have developed the model to analyze the merger situation, mainly for horizontal mergers as “more economics approach to competitive policy”. The study has developed the model to study the factors affecting mergers both from internal and external environment (Heidrich, 2002). It has found that national culture, market conditions and legal and regulatory factors from the external environment must be taken into account. They have claimed that the merger can be successful if the companies have an ability to overcome the negative external factors using positive internal factors (Budzinski & Kretschmer, 2009). Other than these factors, another study has found that economic conditions also influence the mergers. The study has found that the mergers are more as successful in economic down turn conditions (Nigro & Kanter, n.d.; Polonchek & Sushka, 1987). Hence, it can be said that the companies should consider both internal and external factors while analyzing the merge situation.
Motivation behind Merger
There is a series of mergers that have been made between various countries across the world. The newspapers usually provide the insights and tribulations of these mergers. Number of actions is taken on acting on the mergers. However, it is more significant to understand the dynamics of these mergers observing the factors that drive them. Although, two mergers can never be same as all mergers involved in their own motives, challenges and situation, however, some of the critical motives can be found as common.
First of all, the benefits that can derive from the merger, motivates the companies to involve in mergers. The merger helps the small companies to get active investments in the merger to increase their profitability and efficiency of productivity (Riley, 2012). Let’s have an example of Nestle and Perrier that were merged in the industry of Source water. Nestle were taken over the Perrier, promising the growth in the sales and profitability. Before their mergers, the two companies were facing lower sales that were the major reason of their decision to be merged (European Commission, 1992).
Growth and development is found as one of the major factor that motivates the mergers. Rather than developing the own company, it is fastest way to create the growth of the business through acquiring another company internally (Motis, 2007). Consider the case of merger of Sprint and Nextel that were merged to form a large organization to earn high profit and achieve competitive advantage (Team TopHat, 2011). It shows that the companies consider the benefit of profitability and growth of the business engaged in the mergers.
The cost efficiency is one of the major motives that encourage the companies to develop mergers such as the re-allocation of the resources from one to another company reduces the cost. The study has criticized that the company can be more efficient before merger as compare to its efficiency after merger. It has criticized that the cost of the company has increased with merger rather than improving as the merger itself is a costly activity that can even result in the loss of millions and billions (Van Harmelen, 2012). Although, Sprint and Nextel were merged to form successful and efficient business, however, they faced the critical failure condition that results in the loss of billions (Team TopHat, 2011). It means that the environmental factors played a significant role in the merger analysis. The discussed shows the potential benefits and cost to the firms that are engaged in the mergers.
Empirical Evidences on Profitability of Post-Merger
The number of studies has been done to collect empirical evidences on the post merger profitability. Usually, the studies have done using the difference between the pre and post merger income statement and balance sheet. The empirical study of Merger & Acquisition in India has found the merger impacts on the financial ratios of the company in terms of profitability, leverage, liquidity and financial performance. Considering the ratios such as Debtors Turnover Ratio, Fixed Assets Turnover Ratio, Quick Ratio, Total Assets Turnover Ratio, Current Ratio, Return on Capital Employed, Interest Coverage Ratio, Gross Profit Ratio, Net Profit Ratio, Return on Assets, and Debt Equity Ratio, the study has found that the merger of the companies impacts on these ratios, however, the majority impacts were negative (Kalra, 2013).
Odetayo, Sajuyigbe & Olowe, (2013) have also studied the profitability of post mergers in context of Nigerian Banks. They have found the insignificant positive impacts of post merger on the profitability of the banks, in general no significant impacts were found in their study. Another study was conducted to study the empirical evidences on financial performance and mergers. They have found the significant impacts of mergers on the profitability, but the impacts are negative as the profitability has decreased with the mergers of the companies (Akhter & Iqbal, 2014).
The evidences from the empirical studies show that the mergers and profitability has significant relationship but in most of the cases, the mergers impacted negatively on the profitability. It means that the post mergers are not profitable. Hence, it can be said that the profitability cannot be an individual factor to motivate for the mergers as mergers have negative relationship with financial performance of the firms.
Unprofitable Mergers
Although, multiple studies have been done about the mergers for profitability, however, the study empirically has found that the mergers can also be explained in the unprofitable conditions. As it has found above that the mergers are resulted in decrease in profit, therefore, the unprofitability of mergers is very important to be explained. The study has stated that the factors involved in the merger other than maximizing the profit for shareholders can explain the unprofitable mergers. The number of studies has suggested that the aims, implications and objectives of the management can be different from that of shareholders, such as the merger, rather than increasing the profit, decreases the risks for the business and improve the size of the firm, it would be important to management, if or not for the shareholders. It means that the profitability is not the individual benefit of the merger but the unprofitable benefits might also motivate the management to engage in the mergers (Organisation for Economic Co-operation and Development, 2002). The self interest of the managers can cause the development of unprofitable mergers (Riley, 2012).
Other than the positive factors, some barriers also play a role in preventing to realize the profitability of the merger, mainly among the management such as the complex structure and the difficult tasks after merger. In many merger cases, the culture and many other factors have found as the reasons for the failure as they are difficult to overcome, such as the merger of Sprint and Nextel was failed due to the differences in culture and their inefficient decision making to combine the two companies having different cross cultures (Team TopHat, 2011).
Unprofitable mergers can also be explained based on those factors that impact negatively on the success of the merger but avoided when analyzing the mergers outcomes. A study has found that the leadership and the good management is also important for the profitable merger, otherwise, the merger can be directed to unprofitability. These types of factors can also be called as the non financial factors (Hromei & Cuza, n.d.). In this way, the companies must focus on both financial and non financial performance of post merger.
The analysis shows that the post merger success cannot only be defined based on the basis of its profitability and financial outcomes, but the nonprofit mergers can also be developed based on many other factors.
Other Relevant factors
Though, the profitability and environmental factors are found as the major motives for mergers, however, many other studies have also found some other relevant factors that stimulate the companies towards merger. Let’s have a look on few of these major factors or the effects of mergers:
Unilateral effect: In horizontal mergers, the unilateral effects arrive because the level of competition is reduced. The threats to the two companies before merger are facing from each other reduced and they mutually find the way to increase profitability by increasing prices by reducing competition. In oligopoly markets, there is no price war as the single company enjoys the major power (Motis, 2007).
Barriers to Entry Effects: Post mergers develop the barriers to the new entrance in the market as it cause the high competition and enhanced the power of the market (Motis, 2007). In the Merger of Nestle and Perrier, the entry barriers were increased as Nestle and BSN were mainly holding the market, almost 82%. The case analysis by European Commission has found that the concentrations degree after Nestle Merger would definitely be high (European Commission, 1992); it shows that the post mergers cause the market entry barrier effects and reduce the price competition.
The analysis and discussion of the factors show that the mergers can change the market conditions and economic environment if develop in non oligopoly markets. It will help them to reduce the competition and enjoy high profitability, keeping the prices higher.
Conclusion
It is concluded from the analysis; discussion and case study that the horizontal mergers are beneficial as well as potential costs are faced by the companies involved in the mergers. Therefore, it is very important for the firms to analyze the situation that would be developed with the mergers. The market conditions, economic analysis and national culture are some of the major factors to be considered and analyzed to predict the merger situation. The firms based on the discussion and evidences, should merge in the economic down turn and competitive market conditions, as the mergers will be able to change the market into oligopoly.
List of References
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