Why Do Companies Merge with or Acquire Other CompaniesAuthor: Daniel Mather
Mergers and acquisitions, most often known as M&A, are an essential aspect of the corporate landscape. Today we’ll take a look at the main reasons for mergers and acquisitions, as well as the main types of mergers.
What is a company merger?
A merger is a process where two companies come together to form a single entity. Although merger and M&A are often used to mean one and the same thing, there is a technical difference. In an acquisition, one company absorbs the other; in a merger, two companies combine into a new one.
As you’ll see below, companies merge for a variety of reasons — expansion of market share, product diversification, value creation, and even as a way to acquire new talent.
The 5 types of mergers and acquisitions
Among the many different types of mergers and acquisitions, we can highlight five most common types: vertical, horizontal, conglomerate, market extension, and product extension.
Let’s take a more in-depth look at what are five possible reasons for mergers.
A horizontal merger happens between two companies in the same industry. The Facebook acquisition of WhatsApp is an instance of a horizontal merger — both the acquiring company and the acquired one were in the same business of messaging and social media.
Completing a horizontal merger can serve to reduce competition, expand one’s reach, or gain access to the technology of the new company.
Unlike horizontal mergers, in a vertical merger the companies involved operate in the same industry, but at different business points. For instance, a product producer and its distributor.
A typical instance is when the acquiring company extends its reach into the supply chain — such as the merger of a product producer with distribution companies, which helps consolidate the producer’s operations and reduces risk connected to the supply chain.
Conglomerate mergers and acquisitions happen between two companies that operate in entirely different markets.
While less common than a horizontal or vertical merger, a conglomerate integration can be important as a diversification or investment strategy, tapping into new markets. That was the case in the Amazon merger with Whole Foods.
Market extension mergers
In a market extension merger, the integration is between companies that offer the same product or service, but in separate markets.
A good example is the 2011 merger between LAN and TAM — two equal companies which flew to different countries. The merged company, LATAM, gained competitive advantages and significantly expanded its market share.
Product extension mergers
Sometimes, businesses merge so as to extend the reach of their products — that’s what we call a product extension merger. In this kind of mergers and acquisitions, the target company will often provide an opportunity for cross selling products from the other company.
A typical example was the Pepsi-Pizza Hut merger, which provided a new market — every Pizza Hut restaurant — for the famous fizzy drink.
Reasons for companies to merge with or acquire others
As you can see, there are plenty of benefits for both sides of an M&A deal.
Let’s take a look at some of the most typical motivations for mergers and acquisitions.
Some of the main motivations for mergers
Mergers — where one company joins with another to form a new company — can have any or several of a series of motivations, such as:
- To generate revenue synergies. Two businesses often find a path to increasing profits in a merger. As an instance, a company that has a greater cash flow can join up with a company that is less liquid, but has a lot of potential value to offer.
- As a diversification strategy. One reason that companies participate in mergers and acquisitions is to diversify their reach. By forming a new entity with a reach into different markets, companies can avoid having all their eggs in the same basket, improving resilience to shocks in the economy.
- For cost savings. After a merger, 2+2 is sometimes more than 4, as both companies can cut costs by morphing together departments or operations from each. By eliminating redundancies, company mergers can improve expenditure and focus on expanding their market share.
- To increase supply chain pricing power. By moving upstream or downstream, a company can reduce the costs associated with suppliers/providers. This kind of vertical merger is tightly policed in some countries, as it can give disproportionate power to a single company.
- For cross-selling. Cross-selling is another of the most common reasons for mergers. M&A deals will often allow a company to mix its products or services with that of another business — a typical win-win synergy.
- To expand into a larger geographical area. When expanding into a new country or region, a company will often find it best to join forces with another local entity, rather than starting an operation from scratch.
- To reduce risk. Two firms providing the same services can merge to stay afloat in a threatened business, allowing them to lower costs, share customers, and compete as one business.
Some of the main motivations for acquisitions
In an acquisition (where most often the acquiring company purchases a smaller company), some of the benefits mentioned above can occur. Others can be:
- To eliminate competition. Sometimes called a “killer acquisition”, this type of M&A can be a way to get around the competition and maximize a company’s strengths. The new company can even come to establish a monopoly.
- To increase market share. A successful acquisition can be a fast way for business leaders to get ahead, tapping into a larger market share and acquiring new customers.
- To acquire talents. A common motive for acquiring a secondary company can be simply to acquire talented employees with a proven track record.
- To drive innovation. This can happen when a well-established company buys a promising and innovative startup so as to absorb its products — an example was the recent purchase of Figma by Adobe.
- To alleviate a tax burden. Sometimes, a larger company will acquire a business that isn’t doing so well as a way of reporting a loss and reducing its tax liability.
Examples of major mergers and acquisitions
The early Covid-19 pandemic saw a huge spike in big business activities and the number of M&A deals closed. With borrowing rates at a historic low, many larger companies took advantage of the liquidity to acquire other companies that were threatened by the lockdowns.
No industry went unaffected, but some of the biggest movement happened in the pharmaceutical and tech industries. Here are some of the largest companies to merge or close an acquisition deal.
1. Oracle acquires Cerner (2022): $28.3 billion
In a groundbreaking deal, the technology giant Oracle acquired health IT company Cerner in June this year, to the tune of $28 bi. The acquisition gives Oracle a footprint in the healthcare sector, an unusual move for a tech company.
2. Pfizer acquires Arena Pharmaceuticals (2022): $6.7 billion
Pfizer, now a household name in pretty much all the world, hasn’t been sitting on all that pandemic-earned cash. With the purchase of Arena, the vaccine-producer gains access to a new portfolio of cardiology and dermatology treatments.
3. Hyundai acquires Boston Dynamics (2020): $1.1 billion
At a “mere” $1.1 billion, this might not seem the most relevant deal. But it brings significant benefits to the Hyundai Motors Group, which can now expand into the huge developing potential of robotics.
4. Amazon acquires MGM (2022): $8.5 billion
Amazon acquired MGM as a way to increase its Amazon Prime services. The $8-billion deal brings over 4000 movie titles to the Prime offerings, giving Amazon further leverage in the streaming business.
5. Warner Media merges with Discovery (2022): $43 billion
Following AT&T’s acquisition of Time Warner, in 2018, the Warner Media – Discovery merger brings two of the biggest companies in the media industry under one roof.
Now forming one company, the two giants are poised to compete with streaming companies such as Netflix, Apple TV, and Amazon Prime.
As you see, companies merge for any number of reasons: to expand into fresh markets, to gain new talent and tech, and to dominate the competition. As such, M&A deals are a key driver of growth and some of the most relevant big business transactions for a company’s shareholders to keep an eye on.