What is a Merger?
To see a real-life case study and learn further, check out our blog on Disney’s Acquisition of Marvel.
Companies will agree to a merger if they expect a good level of synergy between themselves and if they believe they can generate greater profits together.
An absorption merger usually occurs between companies in the same sector or industry to increase market share or achieve economies of scale. The surviving company takes or ‘absorbs’ the non-surviving company’s assets, liabilities and employees. When that happens, the absorbing company continues to exist, but the absorbed company no longer exists.
- Generally, the acquiring company A is the surviving company; usually due to the fact it has stronger financials or a more significant market reputation than company B.
An amalgamation, also called a consolidation merger, is to create an entirely new company upon two or more companies uniting, usually under a new name. But relatively, this type of merger may require a more complex procedure than an absorption. It would also be involved with the problem of leaving the existing goodwill. So an amalgamation or consolidation may be used in exceptional cases.
For example, smaller companies can be consolidated into a new company to become a much larger one. Or sometimes, previous companies have promising technologies or goodwill but struggle with lawsuits. In such a case, they may leave the existing ones and form a new one.
- As a result, in both types of mergers, two or more businesses are combined into one entity. The assets and liabilities from the two old companies will then be reported on just one joint financial statement.
Incentives Behind a Merger
Like in all business activities, the main goal behind M&A is to maximise shareholder value, reduce competition and gain a competitive advantage in the market.
- Firstly, one company could achieve and utilise synergies with another company if they were to merge. If a merged entity was deemed to have a high level of synergy, the entity would have a better position in the market and a greater competitive advantage.
- A merged company would have a larger pool of resources, potentially a better financial status and possibly economy of scale, an economic phenomenon when it costs less to produce more goods or services. These attributes provide the company with a significant advantage over its competitors.
Below we will define synergy and help to visualise the idea. The synergy effect in business occurs when two companies cooperate and later generate a much better result than they would have if they had stayed separate, whether that be in revenue, market share or profits.
Take this graphic, to help visualise what synergy looks like. Let’s say company A earns $4 million a year and company B earns $3 million a year. If the two were to merge, we would expect their joint revenue to be $7 million. However, due to a positive synergy between the companies, they can amplify their sales beyond $7 million. This circumstance could occur, for example, because company A can now sell to company B’s customers, and company B can now sell to company A’s customers.
There are plenty more possible competitive advantages following a merger.
- Another advantage can include improving cost efficiencies, allowing the company to use less funds without compromising quantity or quality. A prime example of this in M&A falls under marketing. In theory, the marketing budget per company should be halved after a merger, saving costs and boosting profit.
The next graphic provides a good visualisation of higher cost efficiency; say company A spends $4 per unit of goods, and company B spends $4.5 per unit of good. You would expect their combined cost to be around $4. However, due to improved cost efficiency, the cost per unit good ends up being cheaper than when the companies were separated. Cost synergies surrounding successful mergers can arise from layoffs, sharing technology and patents, or one of the company’s research & development resources.
Completed in 2015, the $45 billion amalgamation merger opened both companies up to new locations in which they previously had a low market share. The incentive behind the deal was purely geographical.
Heinz had already obtained the global reach, with 60% of the sales coming from outside the U.S., while Kraft Foods was quite the opposite. If the two were to merge, Kraft Foods could easily push its product into the international market. This was a key component to completing the merger. The joint venture initially succeeded; HeinzKraft became a top five food & beverage company globally and top three in the U.S.
We have looked at this company’s websites and external information to provide you with examples within this post. Check them out here:
- The Kraft Heinz Company
- Analysis Of the Kraft-Heinz Merger (forbes.com)
- BBC News – Kraft shares soar on Heinz merger