Monday, 20 December 2010

Mergers and Demergers

Mergers and Demergers 

How can firms grow?

Firms can grow in two ways: internally and externally.
Internal growth is the growth of a firm through the re-investment of profits.
External growth occurs when a firm integrates with another to create a bigger firm.
What are the different external methods used to grow?

There are four different types of integration: horizontal, forward vertical, backward vertical and conglomerate. 
Horizontal: This is when a firms of the same industry and stage of production integrate. For example a flour mill integrates with another flour mill. This provides a fairly quick way of capturing marker share and achieving economies of scale.
Forward vertical: This is when a firm integrates with another one in the same industry but at a later stage of production for example a mill integrating with a bakery. This allows firms to control it outlets which helps to capture profits and take advantage from economies of scale.
Backward vertical: This is when a firm integrates with a firm in the same industry but at an earlier stage of production for example a mill integrating with a farm. This helps to create barriers to entry as firms benefits from controlling inputs and capturing profit that would have otherwise gone to suppliers.
Conglomerate: This is when firms of two different industries integrate for example when a mill integrates with a cinema chain. This helps diversify the risk for firms and achieve certain economies of scale e.g. financial economies.

Why merger or takeover?

The main purpose behind merging appears to become a dominant firm in a market either through creating barriers to entry or making costs savings and subsequently reducing prices. Conglomerate integration seems to be different this is solely done to diversify risk. However, it can be conceived  that by diversifying risk they can lower prices in one of the markets and dominate it.
Why stay small and not grow?

The main advantage of growing big is to achieve economies of scale. However, there are many advantages of staying small. I have listed some below:
  • They are easier and cheaper to set up. There is less paper work involved.
  • When targeting a niche market you don’t need a big firm and makes no sense to have a big firm when the market is small.
  • They can provide a more personal service to consumers and better treatment to employees.
  • Easier to react to changes in the market (demand and supply)
Why do demergers occur?

  • To improve communication and managerial control.
  • To motivate staff
  • It is a quick way of raising money
  • Perhaps to increase profitability if diseconomies of scale is occurring

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