7. inorganic growth

Question 1

What are the reasons for mergers and takeovers

Answer 1

1. exploit synergies
2. Sometimes Buying another business is cheaper than growing internally
3. Extra cash
4. Defensive reasons
5. Response to economic changes
6. Gain entry into foreign markets
7. Globalisation culture
8. Economies of scale
9. Asset stripper firms
10. Growth is a main objective of the business

Question 2

Reasons for merger/takeover: exploit synergies

Answer 2

1. One of the main motives for integration (i.e, joining) is to exploit the synergies that might exist following a merger or takeover. This means that two businesses joined together form an organisation that is more powerful and efficient than the two companies operating on their own. Synergy occurs when the whole is greater than the sum of the parts’.

Question 3

how do synergies arise

Answer 3

Synergies may arise from economies of scale, the potential for asset stripping (i.e. removing assets; see below), the reduction of risk through diversification (i.e. providing a wider range of products) or the potential for gains by management

Question 4

reasons for mergers/takeover: sometimes cheaper than organic

Answer 4

1. A business may calculate that the cost of internal growth is $80 million. However, it might be possible to buy another company for $55 million on the stock market.
2. The process of buying the company might inflate its price. But, it could still work out much cheaper.

Question 5

reasons for mergers/takeover: extra cash + real world example

Answer 5

1. Some businesses have cash available which they want to use. Buying another business is one way of doing this.
2. eg - In 2018, in many countries around the world the returns on cash were only about 1 per cent. Many businesses would be keen to generate higher returns than this,

Question 6

reasons for mergers/takeover: defensive reasons

Answer 6

1. Mergers take place for defensive reasons, One business might buy another to consolidate its position (i.e. make its position more powerful) in the market.
2. Also, if a firm can increase its size through merging, it may avoid a takeover itself.

Question 7

reasons for mergers/takeover: response to economic changes

Answer 7

1. Businesses respond to economic changes, For example, some businesses may have merged to deal with Brexit in the UK. A larger organisation may be able to cope with the uncertainties arising from Brexit,

Question 8

reasons for mergers/takeover: gain entry into foreign markets

Answer 8

1. Merging with a business in a different country is one way in which a business can gain entry into foreign markets.
2. It may also avoid restrictions that prevent it from locating in a country or avoid paying tariffs on goods sold in that country.

Question 9

reasons for mergers/takeover: globalisation culture

Answer 9

1. The globalisation of markets has encouraged mergers between foreign businesses, This could allow a company to operate and sell worldwide, rather than in particular countries or regions.

Question 10

reasons for mergers/takeover: economies of scale

Answer 10

• A business may want to gain economies of scale. Firms can often lower their costs by joining with another firm.

Question 11

reasons for mergers/takeover: asset stripper + example

Answer 11

1. Some firms are asset strippers, They buy a company, sell off profitable parts, dose down unprofitable sections and perhaps integrate other activities into the existing business.
2. Some private equity companies have been accused of asset stripping in recent years.

Question 12

reasons for mergers/takeover: growth is main objective

Answer 12

1. Management may want to increase the size of the company, This is because the growth of the business is their main objective.
2. It may also be because the financial rewards to managers is often linked to growth and the size of the company.

Question 13

Difference between mergers and takeovers: Merger + real world example

Answer 13

1. A merger is where two (or more) businesses join together and operate as one Mergers are usually conducted with the agreement of both businesses. They are generally ‘friendly’ The name of the new business is often formed out of the names of the two original businesses.
2. For example, one of the biggest mergers recently was between Swiss-based cement producer Holcim Ltd and French cement company Lafarge SA, forming LafargeHolcim. The merger helped to cut costs and cope better with overcapacity (i.e, when an industry produces more than it is able to sell) and weak demand

Question 14

Difference between merger and takeover: takeover + on eval

Answer 14

1. A takeover, sometimes called an acquisition, occurs when one business buys another,
2. Takeovers among public limited companies can occur because their shares are traded openly and anyone can buy them. One business can acquire another by buying 51 per cent of the shares. Some of these can be bought on the stock market and others might be bought directly from existing shareholders.
3. When a takeover is complete, the company that has been ‘bought’ loses its identity and becomes part of the predator company (i.e. the company that `hunted’ the other),
4. However, private limited companies cannot be taken over unless the majority shareholders `invite’ others to buy their shares.

Question 15

how can a firm take control of another company without buying 51% of shares

Answer 15

1. In practice, a firm can take control of another company by buying less than 51 per cent of the shares. This may happen when share ownership is widely spread and little communication takes place between shareholders.
2. In some cases, a predator can take control of a company by purchasing as little as 15 per cent of the total share issue. Once a company has bought 3 per cent of another company, it must make a declaration to the stock market. This is a legal requirement to ensure that the existing shareholders are aware of the situation

Question 16

What do takeovers of PLCs result in? + real world examples

Answer 16

1. Takeovers of public limited companies often result in a sudden increase in their share price. This is due to the volume of buying by the predator and also speculation by investors. Once it is known that a takeover is likely, investors quickly buy shares, anticipating a quick price rise.
2. Sometimes more than one firm might attempt to take over a company. This can result in very sharp increases in the share price as the two buyers bid up the price.

Some of the biggest takeovers in 2017 include:

• CVS Health Corp, a US drugstore chain, agreed to
  pay US$69 billion to buy Aetna, a health insurer
• Walt Disney bought film and television businesses from 21st Century Fox for US$52 billion.

Question 17

what is integration

Answer 17

Integration is when businesses join together to form one

Question 18

what is horizontal integration + real world example

Answer 18

1. Horizontal integration occurs when two firms that are in exactly the same line of business and the same stage of production join together.
2. eg- The merger between the two cement producers, Lafarge SA and Holcim Ltd, is an example of a horizontal merger

Question 19

benefits of horizontal integration

Answer 19

1. a common knowledge of the markets in which they operate
2. less likelihood of failure than merging two different areas of business
3. similar skills of employees
4. less disruption.

Question 20

what is vertical integration + its types

Answer 20

• Vertical integration occurs when firms in different stages of production join together.
• Forward vertical integration is where a business joins with another that is in the next stage of production.
• Backward vertical integration is where a business joins with another in the previous stage of production.

Question 21

what is the main motive for vertical integrations

Answer 21

1. The main motive for such a merger would be to guarantee and control the supply of components and raw materials.
2. Another motive would be to remove the profit margin that the supplier would demand. Forward vertical integration involves merging with a firm that is in the next stage of production.
3. For example, the mountain bike manufacturer might merge with a retail outlet selling bikes. This removes the profit margin expected by the firm in the next stage of production. It also gives manufacturers guaranteed outlets for their output.

Question 22

what is a conglomerate

Answer 22

a very large single business organisation made up of many different businesses producing unrelated products

Question 23

characteristics of conglomerates + example of conglomerate

Answer 23

1. Each business usually operates as a separate entity with its own board of directors.
2. However, each business is still under the control of the owner (conglomerate).
3. The group of businesses are usually acquired through mergers and takeovers.
4. They normally have a wide range of business interests.
5. An example of a conglomerate is Tata, which is based in Mumbai, India. Some of the major companies owned by Tata include Tata Steel, Tata Motors (including Jaguar Land Rover), Tata Consultancy Services, Tata Power, Tata Chemicals, Tata Global Beverages, Tata Coffee and The Indian Hotels Company Limited (Taj Hotels). In 2017, the group’s revenue was over $100 billion

Question 24

Benefits of operating as a conglomerate

Answer 24

1. The main advantage of operating as a conglomerate is that these organisations have a very wide range of business interests. This spreads the risk of business enterprise. If one of the businesses is not doing very well, group revenues and profits can be supported by other businesses in the conglomerate.
2. Another advantage is that they are very large and powerful. They can exploit economies of scale and often have influence in markets.

Question 25

disadvantages of operating as a conglomerate

Answer 25

1. One of the disadvantages of a conglomerate is that diversification can result in difficulties. For example, the specialist skills built up in the original company or group of companies may not be relevant in the new acquisitions. This means the original management team may not fully appreciate the forces that drive success in some of its component parts.
2. Over time, a conglomerate can become a confusing body that fails to maximise its full potential. For example, sometimes a conglomerate may be too slow to get rid of failing companies. This might be due to the fear of losing the required levels of diversification.

Question 26

What are the types of financial rewards from mergers/takeovers

Answer 26

1. stakeholder benefits
2. stronger balance sheet
3. lower costs
4. lower taxes

Question 27

M/T Financial rewards: stakeholder benefits

Answer 27

1. Shareholders in the ‘target’ company often get an immediate premium when taken over. This is because the share price often rises sharply during the process of a bid.
2. eg - Primero shareholders received a 200 per cent premium on the share price following the takeover by First Majestic Silver

Question 28

how does the predator company benefit from a M/T

Answer 28

1. If an acquisition is successful shareholders in the ‘predator’ company (the company making the acquisition) will also benefit.
2. However, their benefits may be long term. It may take a while for the integration process to be completed and there may be a delay in the improvement of financial performance.
3. But if all goes well, shareholders should get higher dividends in the future and the share price should rise. In the long term, job security might also improve as the business becomes stronger due to the merger or takeover. It is also likely that the remuneration packages of some employees (i.e. the money paid to them), particularly senior management, will be better.

Question 29

M/T Financial rewards: Stronger balance sheet

Answer 29

1. A takeover or merger results in a larger single organisation. As a result, the strength of the balance sheet improves. The company will have more assets which are also likely to be more diverse.
2. It is possible that the cash flow of the company will also improve since greater revenues will be generated by the larger organisation.

Question 30

M/T Financial rewards: Lowr costs

Answer 30

1. One of the main motives for mergers and takeovers is to lower costs. Following acquisitions, corporations will be larger. As a result they will be able to exploit economies of scale and lower their costs.

Question 31

M/T Financial rewards: Lower taxes

Answer 31

• It is possible for a company to lower its tax liabilities following a takeover. This is likely to occur if a business acquires another which is located in a `low-tax’ country.
• lTax liabilities can be reduced by registering all the activities of the business in the country where tax rates are lower

Question 32

what are the risks associated with M/T

Answer 32

1. integration costs
2. overpayment
3. bidding wars

Question 33

risks of M/T: Integration costs

Answer 33

1. After a merger or takeover has been agreed, the next step is to physically integrate the two organisations. This can be a very complex, expensive and time-consuming process, the effects of which may be felt for many years.
2. Some of the costs incurred result from the organisational and personnel changes, severance pay for dismissed workers (i.e. the money paid to workers who are forced to leave), technical changes, systems changes, training and many others,
3. It is not uncommon for businesses to underestimate these costs and encounter problems when carrying out the consolidation process. For example, merging two different cultures can be particularly problematic

Question 34

Risks of M/T: Overpayment + real world example

Answer 34

1. There is some evidence to suggest that businesses often pay too much when making an acquisition. Numerous studies over the years reckon that the failure rate of mergers and acquisitions are somewhere between 70 per cent and 90 per cent. One of the main reasons for this is overpayment. This may be because the financial benefits are overestimated, or the costs of acquisition are underestimated, or both, Therefore, the price that the acquirer is willing to pay is inflated.
2. For example, Yahool® felt that it paid too much ($1 billion) for social network site Tumblr, Yahoo! said that assessing the value of a fast-growing new business which has only a small amount of revenue can be difficult. Tumblr’s assets were $353 million, and it liabilities were $114 million, according to Yahoo!,

Question 35

Risks of M/T: Bidding wars + real world example

Answer 35

1. In some cases, it is possible that one business attracts more than one potential buyer. If this happens the price of the acquisition will start to rise, as it would do in an auction. This makes the takeover more expensive.
2. One example of this was the takeover of the American food company Hillshire Brands Co. by Tyson Foods Inc. Previously another company, poultry producer Pilgrim’s Pride, had made an offer of $6.4 billion for Hillshire. However, within 48 hours, Tyson offered $6.8 billion. Pilgrim then raised its bid to $7.7 billion, but this was outstripped by Tyson’s further bid of $8.55 billion, which was finally accepted by Hillshire, This case shows how the cost of a takeover can escalate when more than one business is interested in a target. The overall price rose from $6.4 billion to $8.55 billion, an increase of 33.6 per cent.

Question 36

what are the advantages of inorganic growth

Answer 36

1. speedy growth
2. strategic benefits
3. economies of scale
4. eliminate competition

Question 37

advantages of inorganic growth: speedy growth

Answer 37

1. Businesses can grow far more quickly through mergers and takeovers than growing organically. This means that the benefits of growth, such as larger market share, lower costs resulting from economies of scale, more market power and higher profitability, can be enjoyed more immediately. This might benefit a range of stakeholders.

Question 38

advanatges of inorganic growth: strategic benefits

Answer 38

1. Acquisitions and mergers can help businesses to improve their strategic position. Firms often join together because their activities may complement each other.
2. For example, if two companies join together, collectively they may have a more balanced and diverse global product portfolio. A business can fill gaps in its product portfolio very quickly by making acquisitions.
3. Inorganic growth often means that strengths in one company can compensate for relative weaknesses in the other,

Question 39

advanatges of inorganic growth: economies of scale

Answer 39

1. Economies of scale. An important advantage of inorganic growth is that a company may benefit from economies of scale almost overnight.
2. For example, when two companies join, the new organisation will only need one head office. Therefore, one can be closed down, reducing administration costs significantly.
3. Sometimes, after an acquisition, the size of a business can double. This provides scope for making cost savings in the form of bulk buying, increased specialisation of resources and raising capital.

Question 40

advantages of inorganic growth: eliminate competition

Answer 40

1. Inorganic growth can help to reduce competition in the market. Clearly, if a company takes over a rival, there will be fewer operators in the market, If the process of acquisitions continues in the same market, competition will decrease.
2. This may lead to one firm (or just a few firms) dominating the market, which might allow the remaining companies to raise prices, restricting consumer choice.

Question 41

what are the Disadvantages of inorganic growth

Answer 41

1. regulatory intervention
2. drain resources
3. culture clash
4. alienation of customers
5. loss of managerial control

Question 42

Example of a failed takeover

Answer 42

• Australian conglomerate Wesfarmers bought the UK DIY chain store Homebase for £340 million in 2016.
• However, in 2018 Wesfarmers admitted that the takeover had gone badly. Wesfarmers said the 250-store UK business was expected to make an underlying loss of £97 million in the half-year after a £54 million loss in the year to June 2017. As a result, Wesfarmers is taking a £584 million write down on the business, most of which relates to the value of the Homebase brand.
• A spokesperson for Wesfarmers said the problems were ‘through our own doing’, as the company had ditched popular lines and removed concessions such as Laura Ashley”:, Habitat’⁾ and Argos”..

Question 43

disadvantages of inorganic growth: regulatory intervention

Answer 43

1. Mergers and takeovers in most countries can attract the attention of market regulators (i,e. people or organisations that make sure an industry is being run fairly), If they think that a merger or takeover acts against the interests of the consumer, they have the power to order an investigation. This takes time and may cause delays. After the investigation, the regulator often has the power to recommend that the merger be blocked.
2. Alternatively, it may allow a merger or takeover to go ahead, but with certain conditions. Delays in proceedings and undertakings, such as the sale of assets, take time and cost money

Question 44

disadvantages of inorganic resources: drain on resources + real world example

Answer 44

1. Mergers and takeovers can cost a lot of money.
2. For example, in 2017, Aerospace supplier United Technologies Corp paid $30 billion for avionics and interiors maker Rockwell Collins Inc. This is clearly a very large amount of money and companies that spend such sums on mergers and takeovers have to be very well resourced.
3. If a company grows too rapidly by going on an aggressive acquisition trail, it may stretch financial resources and damage other aspects of the business.

Question 45

disdavanatges of inorganic growth: culture clash

Answer 45

1. When businesses merge, the integration process can be challenging because lots of changes have to be made, One of the main difficulties is merging two different cultures. It can be very difficult to impose a new culture on a business and there may be resistance (e.g. disagreements).
2. For example, a business that prizes flexible working practices and quality of life, may lose important members of staff after merging with a firm where employees are expected to be in the office at all times. If changes are forced through too quickly, without proper discussion for example, this resistance is likely to be stronger.
3. Such problems are likely to be more intense if growth is too rapid and firms are combining two contrasting cultures too quickly.

Question 46

disadvantages of inorganic growth: alienation of customers

Answer 46

1. Companies that are growing too fast might lose touch with their customers. Too much attention and resources get focused on the process of growth. As a consequence, the needs of customers can be overlooked.
2. For example, after a takeover or merger the name of a business may change; some consumers may be confused, wondering what the new brand is and what values might be attached to it. Ultimately, this could damage the image of the company and result in the loss of customers,

Question 47

disadvanatges of inorganic growth: loss of managerial control

Answer 47

1. If growth is too rapid the company might get too big too fast. This can result in a loss of control by the senior executives.
2. A bigger organisation means that additional layers of management are required. This means that communication channels take longer to reach the intended recipient and might impact negatively on the chain of command. As a result, costs may start to rise as diseconomies of scale set in

Question 48

define globalisation of a market

Answer 48

where markets become so large that products could be sold anywhere in the world

Question 49

define synergy

Answer 49

the combining of two or more activities or businesses which creates a better outcome than the sum of the individual parts