A merger occurs when two firms join together to form one. The new firm will have an increased market share, which helps the firm gain economies of scale and become more profitable. The merger will also reduce competition and could lead to higher prices for consumers.
The main benefit of mergers to the public are:
1. Economies of scale. This occurs when a larger firm with increased output can reduce average costs. Lower average costs enable lower prices for consumers.
Different economies of scale include:
- Technical economies; if the firm has significant fixed costs then the new larger firm would have lower average costs,
- Bulk buying – A bigger firm can get a discount for buying large quantities of raw materials
- Financial – better rate of interest for large company
- Organisational – one head office rather than two is more efficient
A merger can enable a firm to increase in size and gain from many of these factors.
Note, a vertical merger would have less potential economies of scale than a horizontal merger e.g. a vertical merger could not benefit from technical economies of scale. However, in a vertical merger, there could still be financial and risk-bearing economies.
Some industries will have more economies of scale than others. For example, a car manufacturer has high fixed costs and so gives more economies of scale than two clothing retailers. More on economies of scale
2. International competition. Mergers can help firms deal with the threat of multinationals and compete on an international scale. This is increasingly important in an era of global markets.
3. Mergers may allow greater investment in R&D This is because the new firm will have more profit which can be used to finance risky investment. This can lead to a better quality of goods for consumers. This is important for industries such as pharmaceuticals which require a lot of investment. It is estimated 90% of research by drug companies never comes to the market. There is a high chance of failure. A merger, creating a bigger firm, gives more scope to tolerate failure, encouraging more innovation.
4. Greater efficiency. Redundancies can be merited if they can be employed more efficiently. It may lead to temporary job losses, but overall productivity should rise.
5. Protect an industry from closing. Mergers may be beneficial in a declining industry where firms are struggling to stay afloat. For example, the UK government allowed a merger between Lloyds TSB and HBOS when the banking industry was in crisis.
6. Diversification. In a conglomerate merger, two firms in different industries merge. Here the benefit could be sharing knowledge which might be applicable to the different industry. For example, AOL and Time-Warner merger hoped to gain benefit from both the new internet industry and an old media firm.
Examples of mergers
2017 – Amazon merger with Whole Foods. Amazon has knowledge and expertise in online shopping. Whole Foods is a major food retailer. It is hoped the merger will enable Whole Foods to benefit from Amazon’s existing infrastructure and online delivery.
2000 Glaxo Wellcome Plc and SmithKline Beecham Plc – became GlaxoSmithKline. Hoped larger firm more powerful in developing R&D.
2014 Facebook – WhatsApp –
2016 Microsoft acquired LinkedIn ($26.2 billion)
Evaluation of mergers
The desirability of a merger will depend upon several factors such as:
- Is there scope for economies of scale? Are there high fixed costs in the industry?
- Will there be an increase in monopoly power and a significant reduction in competition?
- Is the market still contestable? (is there freedom of entry and exit)
Because of this the Competition Commission looks at each individual case and assess its relative merits and demerits.