Businesses acquire and merge with other businesses because they see some advantages to these moves. A conglomerate merger is one in which a business acquires another business to extend its product offerings or market share. This sort of move provides some advantages to the combined entity, such as increased efficiency and diversification of risk.
Since a conglomerate is made up of many different business units, it can use the cash the business generates to the most efficient use. If different business units come up with different business plans for the use of the firm’s capital, the management will award the cash to the use that gets the best return. This makes for efficient use of the firm’s capital. Not only that, the business can also deploy managers as the need arises, making the most efficient use of human capital too.
By acquiring firms in different markets, businesses are able to diversify away their risks. If a firm has exposure to market products, it is not subject to changes in demand for any one product. For instance, if a firm sells both lawn mowers and snowblowers, it does not experience a dip in sales during the winter, when lawn mower sales tend to be down. During the winter, the sales of snowblowers, which tend to be up, make up for the dip in lawn mower sales.
Economies of Scale
Another benefit that businesses see in conglomerate merger is they anticipate economies of scale. Since the business uses the same managers to oversee a number of businesses, its cost of management per unit goes down by operating on a larger scale. Costs of advertising, research and development, and computer support are also spread out across a larger number of business units. This means the business derives the benefits of lower costs per unit of output.
A conglomerate merger is also likely to produce synergies for the combining entities. Synergy is a situation in which the sum of the combined unit is more than the sum of each individual unit. This situation comes about as a result of increased sales and earnings for the combined business each business would not have obtained on its own. This synergistic effect comes about as a result of all the efficiencies a large conglomerate enjoys.