Motives for Mergers and Acquisitions

7. Increased Managerial Skills

Occasionally, a firm will have good potential that it finds itself unable to develop fully because of deficiencies in certain areas of management or an absence of needed product or production technology. If the firm can not hire the management or develop the technology it needs, it might combine with a compatible firm that has the needed managerial personnel or technical expertise. Any merger, regardless of the specific motive for it, should contribute to the maximization of owner’s wealth.

8. Reduction in Tax Liability

Under Income Tax Act, there is a provision for set-off and carry forward of losses against its future earnings for calculating its tax liability. A loss making or sick company may not be in a position to earn sufficient profits in future to take advantage of the carry forward provision. If it combines with a profitable company, the combined company can utilize the carry forward loss and save taxes with the approval of government. In India, a profitable company is allowed to merge with a sick company to set-off against its profits the accumulated loss and unutilized depreciation of that company. A number of companies in India have merged to take advantage of this provision.

When two companies merge through an exchange of shares, the shareholders of selling company can save tax. The profits arising from the exchange of shares are not taxable until the shares are actually sold. When the shares are sold, they are subject to capital gain tax rate which is much lower than the ordinary income tax rate.

A strong urge to reduce tax liability, particularly when the marginal tax rate is high is a strong motivation for the combination of companies. For example, the high tax rate was the main reason for the post-war merger activity in the USA. Also, tax benefits are responsible for one-third of mergers in the USA.

9. Economies of Scale

Economies of scale arise when increase in the volume of production leads to a reduction in the cost of production per unit. Merger may help to expand volume of production without a corresponding increase in fixed costs. Thus, fixed costs are distributed over a large volume of production causing the unit cost of production to decline. Economies of scale may also arise from other indivisibilities such as production facilities, management functions and management resources and systems. This happens because a given function, facility or resource is utilized for a large scale of operation. For example, a given mix of plant and machinery can produce scale economies when its capacity utilisation is increased. Economies will be maximized when it is optimally utilized. Similarly, economies in the use of the marketing function can be achieved by covering wider markets and customers using a given sales force and promotion and advertising efforts. Economies of scale may also be obtained fro the optimum utilisation of management resource and systems of planning, budgeting, reporting and control. A company establishes management systems by employing enough qualified professionals irrespective of its size. A combined firm with a large size can make the optimum use of the management resource and systems resulting in economies of scale.

10. Vertical Integration

Vertical integration is a combination of companies of companies business with the business of a supplier or customer generally motivated by a pure desire:

1. To secure a source of supply for key materials or sources
2. To secure a distribution outlet or a major customer for the company’s products
3. To improve profitability by expanding into high margin activities of suppliers and customers.

Thus, vertical merger may take place to integrate forward or backward. Forward integration is where company merges to come close to its customers. A holiday tour operator might acquire chain of travel agents and use them to promote his own holiday rather than those of rival tour operators. So forward or downstream vertical integration involves takeover of customer business.

Backward integration occurs when a company comes close to its raw materials or suppliers. The real gain can be achieved by integrating backward if raw material market is not perfectly competitive and firm has to buy raw materials at monopolistic prices hence merge to obtain control of supplies. There are many reasons why firms want to be integrated vertically at different stages. Some of these reasons are technological economies like avoidance of reheating and transportation cost as in the case of iron and steel producer. Transactions within a firm might eliminate costs of searching for prices, contracting, advertising, costs of communicating and co-ordination. Proper planning for production and inventory management may improve due to more efficient information flow within a single firm. Further, these merger help avoid inefficient market transactions and result in reduced exchange inefficiencies.

Tata Tea’s acquisition of consolidated coffee which produces coffee beans and Asian Coffee, which possesses coffee beans, was also backward integration which helped reduce exchange inefficiencies by eliminating market transactions. The recent merger of Samtel Electron services (SED) with Samtel Color Ltd. (SCL) entailed backward integration of SED which manufactures electronic components required to make picture tubes with SCL, a leading maker of color picture tube.

Thus, when companies engaged at different stages of production or value chain merge, economies of vertical integration may be realized. For example, the merger of a company engaged in oil exploration and production (like ONGC) with a company engaged in refining and marketing (like HPCL) may improve coordination and control.

Vertical integration, however, is not always a good idea. If a company does everything in-house, it may not get the benefit of outsourcing from independent suppliers who may be more efficient in their segments of the value chain.

11. Early Entry and Market Penetration

An early mover strategy can reduce the lead time taken in establishing the facilities and distribution channels. So, acquiring companies with good manufacturing and distribution network or few brands of a company gives the advantage of rapid market share.

The ICICI, a leading financial institution secured a foot hold in retail network through acquisition of Anagram Finance Company and ITC classic. Anagram had a strong retail franchise, distribution network of over fifty branches in Gujarat, Rajasthan and Maharastra and a depositor base of over two lakhs depositors. ICICI was therefore attracted by the retail portfolio of Anagram which was active in lease and hire purchase, car purchase, truck finance, and customer finance. These acquisitions thus helped ICICI to obtain quick access to well dispersed distribution network.

Further, market penetration means developing new and large markets for a company existing products. Market penetration strategy is generally pursued within markets that are becoming more global. Cross border merger are a means of becoming or remaining major players in such markets. Hence, this strategy is mainly adopted by MNC’s to gain to new markets. They prefer to merge with a local established company which knows behavior of market and has established customer base. One such example is Indian market. Few instances of MNC’s related mergers are:

1. Whirlpool Corporation’s entry into India by acquiring Kelvinator India.
2. Coca Cola while re-entering India market in 1993 acquired Parle, the largest player in market with several established brands and nationwide bottling and marketing network.
3. H.J. Heinz entered into India through acquisition of Glato Industries.
4. HLL acquired Dollops, Kwality, Milk food to gain an entry into ice cream market with the help of their marketing networks, production facilities, brands etc.

12. Revival of Sick Companies

An important motive for merger is to turn around a financially sick company through the process of merger.  Amalgamation taking place under the aegis of Board for Industrial and Financial Reconstruction  (BIFR)  fall under this category.

BIFR found revival of ailing companies through the means of their with healthy company as the most successful route for revival of their financial wealth. Firstly, the purpose is to revive a group of sick companies by merging it with groups of healthy company by obtaining concessions from financial institution and government agencies and obtaining benefits of tax concessions u/s 72A of Income Tax Act, 1961. Secondly, it also helps to preserve group reputation. Some of the group companies which have amalgamated through the BIFR include Mahindra Missan Allwyn with Mahindra and Mahindra, Hyderabad, Allwyn with Voltas etc.

Read More:  Merger Through BIFR