The Advantages of Business Combinations

Business combinations, which in many cases take the form of mergers and acquisitions, can help businesses take advantage of the size and strength of one another, therefore making the combined entity stronger than that of its individual parts.

At some point a company can grow too large, with its resources stretched too thin to grow further in a consistent manner. At that point, combining with other business entities allows both parties to work together as a team under one management umbrella. Some of the reasons for business combination include elimination of competition, the sharing of assets and talent, and expansion in geographical areas which may have been impossible as an individual entity.

There are many reasons why a company would seek to combine with another. Combinations are usually done in three different types of transactions:

A merger occurs when two companies combine and one company ceases to exist after being absorbed.

An acquisition takes place when the two companies combine and the acquiring company takes a majority stake in the target company. In many acquisition cases, both companies retain their name and identity as separate companies.

Lastly, a consolidation occurs when the combination of two companies creates an entirely new company, usually with a combined name or new name altogether. If you’ve ever watched a movie from DisneyPixar, you have an idea of how the 2006 consolidation of the historic franchise of Disney’s animated characters joined forces with the renowned animated studio to form an animated movie powerhouse worth billions of dollars.

There are many reasons why two or more companies would want to come together. Call it strength in numbers, but combining forces in the business world can often lead to advantages that include better financial performance and market exposure for all involved, rather than continuing to operate as individual companies.

Synergy. Companies can suffer from growing pains, and by combining business management and activities with another company they can both enjoy increased performance efficiency and lower costs across the board. One company may be stronger in one area, and can help give the second one a lift.

By creating a synergistic environment, it can mean more confidence from shareholders, which in turn can also mean more interest from investors. A company that was previously in a period of decline may now find itself in a period of renewed growth.

Overall growth. At some point, a company can get so large that it becomes unable to attract more customers in its market and therefore struggles to increase profits. It may be that the company is simply in what is called the “mature phase” of its life cycle. In this case, the only way to grow is to take market share from the competition.

Among the reasons for combining businesses with a competitor is that a business can scoop that portion of the market share without doing a whole lot. Usually, the amount of increased revenue that the acquiring company stands to gain far outweighs the amount paid for the merger. At the same time, the merged company enjoys the savings of sharing assets in staff and production assets.

Cost-savings. In many mergers and acquisitions, both companies benefit from the advantages of business combination because the combination eliminates entire levels of costs. Unfortunately, in many mergers, employees have to be let go because their jobs become redundant and keeping them on board would result in unnecessary costs. From a solely financial standpoint, this is exactly what company management and shareholders want.

There can also be cost-saving benefits through a company’s production process during a merger. If a company buys up a major supplier, it saves on major supply costs it no longer incurs, and by scooping up distributors, shipping costs will generally decrease.

Competitive advantage. Many mergers and acquisitions are born out of a desire to decrease competition – both current and future. By merging now with a competitor, it becomes easier to lock in a bigger piece of the market. In some cases, combining with a competitor and becoming a larger company with more assets allows the company to be a force to be reckoned with on a global scale, allowing the newly formed company to compete on an international scale.

In 2017, the merger of Amazon and Whole Foods combined the forces of a food retailer with Amazon’s existing online delivery service and gave birth to an entire industry of shopping experiences, including a world where customers no longer need to go to the store to do their grocery shopping.

Vertical Combinations. A vertical business combination occurs when a company acquires another company involved in the production process in the same industry. One reason for business combination is that a company can find that it will save money or increase market share by owning a separate business that it needs – but doesn’t necessarily want to pay more for its services.

Think of an automobile manufacturer that acquires a tire company. By combining entities, the automaker enjoys the advantages of business combination, ensuring it will always have a steady supply of tires available while the tire company ensures it will always have a customer.

The companies also gain new distribution channels – such as through car dealerships that carry the brand of tires exclusively. By implementing this type of merger, companies can strengthen their supply chains, reduce cost of producing components and increase profits.

Horizontal Combinations. Also known as Horizontal Integration, this occurs when two business entities in the same industry come together to form a stronger entity under one management umbrella. Essentially, both businesses are involved in the same activities, but find that they can become stronger and better companies by working together.

If soft drink companies Pepsi and Coca-Cola decided to merge together, rather than operate as competitors, that would be considered a horizontal merger.

A prime example of a horizontal combination is the 2012 merger of Facebook and Instagram for $1 billion. Both entities were well-known social media platforms whose customers used their photo-sharing services. By combining, they were able to both remain separate entities while Facebook was able to increase its market share, reduce competition and reach into new audiences.

Circular Combinations. This combination takes place when two business entities with different products come together under the same management. By combining the strengths of two different entities, the merged company can offer a great range of products, and take advantage of such assets as research and development facilities, resource sharing and diversification.

Take the two wildly different industries of corn production and fuel production in the United States. In recent years, fuel companies such as Shell Oil have come under pressure to develop new alternative and environmentally friendly forms of fuel for motor vehicles. At the same time, the corn industry has seen a dip in demand, as customers have begun to question the health implications of eating large amounts of corn syrup, once a major ingredient in many processed foods.

As it turns out, corn makes a great ethanol fuel, and since 2001, fuel companies like Shell have been partnering with corn growers to produce E85, a corn-based fuel that, in turn, is increasingly used to power automobiles from car makers such as Ford, Dodge and Toyota.

Diagonal Combination. This occurs when two or more business units providing subsidiary services combine under the same management. Imagine a car manufacturer joining with a firm that provides repairs and maintenance. By combining forces, the new business unit becomes much larger and self-sufficient, one of the advantages of business combination.

This differs from a vertical combination because the two companies can now become one, rather than work in partnership.

While the positive reasons for business combination usually outweigh the negative, there are also some negative effects of business combination that should not be overlooked, and will affect a company’s decision of whether or not to go through with a partnership with another company.

Higher consumer prices. A merger often reduces competition, but can result in rising prices for customers, an effect of a new company gaining power as a monopoly, especially in industries where the merger leads to fewer choices for customers.

With the knowledge that the new company is a market leader, management can be tempted to raise prices – and in many cases customers will pay it. But the ensuing bitterness from a disenfranchised customer base may be difficult to reel back in.

Communication issues. With growth in size comes the inevitable difficulty in communication between the different departments and people in charge of the company, who in some cases may be located in different countries. It’s extremely important for merged companies to maintain proper communication channels – with their customers, staff and other administration officials.

Job losses. The unfortunate negative effect of business combination of a merger or acquisition can be the loss of many jobs across two or more companies, as the new entity struggles to eliminate redundancy of roles in the company.

In situations where entire underperforming sectors of a company are eliminated, this can result in large job losses and low morale among current remaining employees.

Non-financial factors. Many reasons for merging with another company revolve around money and how much can either be saved or gained, but there are effects of business combination that can derail the advantages. For instance, a merger may cause job losses in an already financially depressed area of the country.

Perhaps the merger is with a company whose former CEO had unpopular political views, or the company being purchased had a history of illegal practices. In either of these cases, the new company will have to deal with the ramifications of the situation – even if the transaction resulted in a financial windfall.

Things don’t work out. Sometimes what seems like a perfect combination at first simply doesn’t work out, because the two corporate cultures don’t work well together, or because unforeseen factors in the economy work against the new merger.

When America Online and Time Warner came together in 2000 in a $165 billion acquisition, the result was supposed to be the largest media company in the world in the middle of the dot-com explosion. The different cultures of the two didn’t work well together, and a few months later the dot-com bubble burst and sent the economy into a recession. AOL stock alone went from a reported $226 billion to about $20 billion.