Why do companies merge with or acquire other companies?

By Rob Renaud AAA
A:

Some of the reasons for mergers and acquisitions (M&A) include:

1. Synergy: The most used word in M&A is synergy, which is the idea that by combining business activities, performance will increase and costs will decrease. Essentially, a business will attempt to merge with another business that has complementary strengths and weaknesses.

2. Diversification / Sharpening Business Focus: These two conflicting goals have been used to describe thousands of M&A transactions. A company that merges to diversify may acquire another company in a seemingly unrelated industry in order to reduce the impact of a particular industry's performance on its profitability. Companies seeking to sharpen focus often merge with companies that have deeper market penetration in a key area of operations.

3. Growth: Mergers can give the acquiring company an opportunity to grow market share without having to really earn it by doing the work themselves - instead, they buy a competitor's business for a price. Usually, these are called horizontal mergers. For example, a beer company may choose to buy out a smaller competing brewery, enabling the smaller company to make more beer and sell more to its brand-loyal customers.

4. Increase Supply-Chain Pricing Power: By buying out one of its suppliers or one of the distributors, a business can eliminate a level of costs. If a company buys out one of its suppliers, it is able to save on the margins that the supplier was previously adding to its costs; this is known as a vertical merger. If a company buys out a distributor, it may be able to ship its products at a lower cost.

5. Eliminate Competition: Many M&A deals allow the acquirer to eliminate future competition and gain a larger market share in its product's market. The downside of this is that a large premium is usually required to convince the target company's shareholders to accept the offer. It is not uncommon for the acquiring company's shareholders to sell their shares and push the price lower in response to the company paying too much for the target company.

For more on this topic, read The Basics Of Mergers And Acquisitions and The Wacky World Of M&As.

RELATED FAQS

  1. How much of the profitability in the Internet sector is concentrated in the few major ...

    See how much profitability of the Internet sector is concentrated, and where the most value from Internet-based services ...
  2. What is the difference between consumer surplus and economic surplus?

    Learn the difference between consumer surplus and economic surplus, how the concepts are related and the important theoretical ...
  3. What techniques are most useful for hedging exposure to the banking sector?

    Learn how investors hedge exposure to the banking sector by investing in more aggressive sectors and also by investing in ...
  4. How is accounting in the United States different from international accounting?

    Learn how accounting standards differ between the International Financial Reporting Standards, or IFRS, and generally accepted ...
RELATED TERMS
  1. Paid Syndication

    Web syndication is the promotion or inclusion of content on a ...
  2. Controlled Insurance Program (CIP)

    An insurance policy which consolidates coverage for contractors ...
  3. Chain Ladder Method (CLM)

    A method for calculating the claims reserve requirement in an ...
  4. Expected Loss Ratio (ELR) Method

    A technique used to determine the projected amount of claims ...
  5. Frequency-Severity Method

    An actuarial method for determining the expected number of claims ...
  6. Injury-In-Fact Trigger

    A coverage trigger theory that states that policy coverage activates ...

You May Also Like

Related Articles
  1. Options & Futures

    Key Factors Of The Russell 2000 Index

  2. Stock Analysis

    There Are No Good And Bad Stocks, There's ...

  3. Charts & Patterns

    Why These May Be the Top 4 Growth Stocks ...

  4. Economics

    Gambling on Macau: Too Risky?

  5. Stock Analysis

    Why the House (and Las Vegas Sands) ...

Trading Center