7.8 Benefits to the Firm of a De-Merger Flashcards
What is a demerger?
A demerger is the breaking up of one large firm into smaller, separate firms.
Benefit: By demerging a business can raise funds
By demerging, a business can raise funds. As businesses sell off less profitable or inefficient parts of their business, funds will flow in as a result. Consequently the business can use the surplus revenue to payoff loans and/or for re-investment purposes.
Benefit: A demerger can combat diseconomies of scale
A demerger can combat diseconomies of scale. If, through mergers or other means, a business suffers from the problems of communication, control, coordination or motivation, then selling off part of the company to create separate organisations will reduce overall output. Therefore, although any economies of scale are likely to also be reduced, there could be a greater benefit of lower average costs overall allowing the business to become more competitive.
Benefit: Demergers can increase profits
Demergers can increase profits. This is because smaller separate firms benefit from specialization and, management have a much narrower focus on business operations. As a consequence, efficiency and productivity will increase, lowering costs and widening profit margins.
Benefit: Scrutiny of competition authorities will be lower
Scrutiny of competition authorities will be lower. Demerging could be a direct response to government regulation where the large firm may have been accused of excessive monopoly power, in which case creating smaller companies in separate markets will reduce the chance of intervention by competition authorities, which usually are against the interests of the firm.
Benefit: Demergers can increase the share price of a company
Demergers can increase the share price of a company. This is because loss-making or non-profitable areas are separated, and when the remaining business prospers with greater efficiency, productivity, and management, more investors are likely to be attracted to buy shares in the company. Higher share prices increase the value of the company and make it easier to raise funds in the future.
Benefits to society: Demerger can result in allocative efficiency
A demerger can result in allocative efficiency benefitting consumers. This is because if the market is more competitive and the business prospers with greater efficiency, specialization, and focused management, the consumer interest is more likely to be at the forefront of decision-making. As a consequence, costs of production will be lower resulting in lower prices and higher consumer surplus. Resources will perfectly follow consumer demand with high quantity, quality, and greater choice available for consumers.
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Benefits to society: Demerger can result in dynamic efficiency
A demerger can result in dynamic efficiency if higher profits are made as businesses specialize and separate. This is where high profits are reinvested back into the company in the form of R&D, innovation, new or upgraded capital machinery, technology advances, factory expansion, etc. Such reinvestment can improve living standards and affordability for consumers while increasing profit margins and reducing costs of production for firms over time.
Benefits to society: Workers could benefit from greater morale and job opportunities
Workers could benefit from greater morale and job opportunities post a demerger. With more focus by management on worker training and performance, it is likely that employees will feel highly valued members of the company, deriving greater satisfaction from work. Further, more jobs are likely as gaps appear in departments following a demerger. Consequently, workers may be able to move into promoted posts and earn higher incomes, but even those who remain in the same position are likely to be more productive benefitting both themselves and the firm.
Costs of a Demerger: Parts of company could be sold off at a huge loss
The parts of the company could be sold off at a huge loss. This could be because either demand for the business is very low or the company had been wrongly undervalued. If this occurs, the reputation of the company could be damaged, and shareholder satisfaction severely harmed, creating problems of raising finance through share issues in the future.
Costs of a Demerger: Lack of finance availabkle for re-investment
Demergers may result in a lack of finance available for reinvestment. This is because with firms now being separate and much smaller in size, the profit that each firm makes will be lower than the total of a very large organisation. Therefore, even though a firm may be individually profitable and able to partake in some reinvestment, the scale of this is much less than when merged. This is a more significant concern for a business that is making a loss with one of the goods in their product line or if the business is loss-making overall as there can be no benefits of cross-subsidization, harming both the health of that firm but also consumers who may not be able to purchase goods they demand.
Costs of a Demerger: Lost benefits of inorganic growth
See Benefits of Inorganic Growth (7.6)
