Pros and Cons of Mergers

A look at the pros and cons of mergers. Are mergers in the public interest or are mergers just beneficial for top executives and shareholders? When looking at mergers it is important to look at the subject on a case by case basis as each merger has a different possible benefits and costs. These are the most likely advantages and disadvantages of a merger.

Pros

1. Network Economies. In some industries, firms need to provide a national network. This means there are very significant economies of scale. A national network may imply the most efficient number of firms in the industry is one. For example, when T-Mobile merged with Orange in the UK, they justified the merger on the grounds that:

“The ambition is to combine both the Orange and T-Mobile networks, cut out duplication, and create a single super-network. For customers it will mean bigger network and better coverage, while reducing the number of stations and sites – which is good for cost reduction as well as being good for the environment.”

2. Research and development. In some industries, it is important to invest in research and development to discover new products / technology. A merger enables the firm to be more profitable and have greater funds for research and development. This is important in industries such as drug research.

3. Other Economies of Scale. The main advantage of mergers is all the potential economies of scale that can arise. In a horizontal merger, this could be quite extensive, especially if there are high fixed costs in the industry. see: Examples of economies of scale. Note: if the merger was a vertical merger or conglomerate merger, the scope for economies of scale would be lower.

4. Avoid Duplication. In some industries it makes sense to have a merger to avoid duplication. For example two bus companies may be competing over the same stretch of roads. Consumers could benefit from a single firm with lower costs. Avoiding duplication would have environmental benefits and help reduce congestion.

5. Regulation of Monopoly. Even if a firm gains monopoly power from a merger, it doesn’t have to lead to higher prices if it is sufficiently regulated by the government. For example, in some industries the government have price controls to limit price increases. That enables firms to benefit from economies of scale, but consumer don’t face monopoly prices.

Cons of Mergers

1. Higher Prices. A merger can reduce competition and give the new firm monopoly power. With less competition and greater market share, the new firm can usually increase prices for consumers. For example, there is opposition to the merger between British Airways (parent group IAG) and BMI.  (link Guardian) This merger would give British Airways an even higher percentage of flights leaving Heathrow and therefore much scope for setting higher prices. Richard Branson (of Virgin) states:

“This takeover would take British flying back to the dark ages. BA has a track record of dominating routes, forcing less flying and higher prices. This move is clearly about knocking out the competition. The regulators cannot allow British Airways to sew up UK flying and squeeze the life out of the travelling public. It is vital that regulatory authorities, in the UK as well as in Europe, give this merger the fullest possible scrutiny and ensure it is stopped.

2. Less Choice. A merger can lead to less choice for consumers.

3. Job Losses. A merger can lead to job losses. This is a particular cause for concern if it is an aggressive takeover by an ‘asset stripping’ company – A firm which seeks to merge and get rid of under-performing sectors of the target firm.

4. Diseconomies of Scale. The new firm may experience dis-economies of scale from the increased size. After a merger, the new bigger firm may lack the same degree of control and struggle to motivate workers. If workers feel they are just part of a big multinational they may be less motivated to try hard.

The desirability of a Merger depends upon:

1. How much is competition reduced by? E.g. A merger between Tesco and Sainsburys would lead to a significant fall in competition amongst UK supermarkets. This would lead to higher prices for basic necessities.
2. How significant are economies of scale in the industry? A merger between Tesco and Sainsburys may enable some economies of scale, but it would be relatively low compared to two oil drilling companies. The fixed costs in oil exploration are much higher. Therefore, there is more justification for a merger in oil exploration than in supermarkets.
3. How Contestable is the market. After the merger can new firms still enter or are barriers to entry sufficiently high to deter new firms?

 Case Studies of Mergers

• Rank and Gala Casinos 2012