Please enable JavaScript.
Coggle requires JavaScript to display documents.
Unit 4 lecture (Vertical integration:
A competitive strategy wheer a…
Unit 4 lecture
Vertical integration:
A competitive strategy wheer a business takes over one or more stages in the production of a product
A company opts for vertical intefration to gain control over the supply of the different aspects
Frward integration - manufacture and sales
Backward integration - raw materials and production
Balancd integration - a bit of both
Motives for vertical integration
- Unreliability of current
- Prices unstable
- Big margins earned by supliers
- Company has spare resources
- Industry is expectd to grow significantly
- Smooth the suppy chain
- Efficiency
- Absorb profits
- Increase entry bariers for new entrants
Downsides to vertical integrationQuality of goods supplied may fall because of a lack of competition
- Flexibility to increase or decrease production of raw materials might be lost as need to sustain economy of scale
- It may be difficult for the company to focus on its core competencies
-
Motives for horizontal intgration
- Economy of scale
- increased differentiation
- Increased market power
- Ability to enter new markets
Disadvantages of horizontal int
- procedures become too rigid
- Synergies between the companies may be elusive or non existent - eg failed integration of software
Merger/Acquisition
- Merger: business are roughly the same size and there is agreement among managers and owners
- Takeover - typically a larger business acquires control of a smaller business. Generally a takeover of assets with some resistance from shareholders
In practice it is sometimes difficult to clarify if merger or takeover
THe rationale for mergers:
- present value of combined business - worth more as combined
- Present value of the target business
- A gain - increased income or reduced expense
Motives for mergers:
- Benefits of scale:
- Eliminating a competitor
- Eliminate inefficient management
- Complementary resource
- Protecting sources of supply or revenue
Benefit of economy of scale:
- larger business able to negotiate better prices in exchange for larger orders
- Lower average cost should enable lower prices for consumers
- Lower cost of finance when larger sums are being raised
- Potential for savings - operating costs duplicated
- A vertical merger would have less potential exonomy of scale than a horizontal, however still financial and risk bearing economies
Examples of economy of scale:
- Specialisation and division of labour
- Technical - for example using factories on full capacity
- Bulk Buying
- Spreding overheads
- Risk bearing economies - some investments are expensive and therefore are risky
- Marketing - eg tv advertising not feasible for smaller company
- Container principle
- International competition
- Protect an industry from closing
- Diversification
- External economies - whole industry gets bigger and firms benefit from better infrastructure
- Greater investment in R&D - due to more profit, more ability to tolerate failure
- Network economies: eg merger of TMobile and Orange
Diseconomies of scale:
- Poorer communication ina large firm
- Alienation of workers
- Lack of control (skiving might increase due to larger numbers)
- Increasing costs - increased organising and controlling a large business
- A merger can reduce competition - firm can gain a monopoly and increase prices for consumers. (example of BA trying to take over BMI)
Overcoming diseconomies of scale:
- Split firm into manageable sections
- Minimum point of output necessary to achieve the lowest average cost of production in long run on average cost curve
- Known as minimum efficient scale
Eliminating competition:
- Horizontal merger normally required to increase market share
- Potential problems are that customer will have less choice
- Government will try to protect consumer
Eliminate weak management
Takeover offers the chance to install a stronger management team
Could be a solution to the Agency problem, where manaers act in self interest
Protecting sources of supply or revenue
May be a risk that supplier will switch output to a competitor. Bsiness may decide to acquire the supplier
For the same reason a firm may decide to acquire a customer business if they cnsider switching to a different supplier
Diversification:Business invests in other industries to reduce risk bu having income streams from different industries - more stable pattern of profitUndervalued shares:Managers believe that the shares of a target firm are undervalued.
- If we accept that the market is efficient in the semi strong form then this motive is difficult to justify
- It is possible that the managers of the bidding firm have access to inf that the market does not
Managment interests and goalsMerger may be taken in the interests of the managers.
eg - take over a firm for empire building
- Excitement and prestige of merger/takeover
Desireability of a merger
- How much is competition reduced by?
- How significant are economies of scale in the industry?
- How contestable is the marker? (Can new firms still enter or are barriers of entry sufficiently high?)
- What are the objectives of the merger? (efficiency or success of managers?)
Case Study - Sainsburys and Asda
- Promise is that it will lead to lower prices, no job losses, and neccessary to deal with new entrants (ALdi/Lidl/Amazon)
- Others are more cautious as the new firm will control 30% of market, creating a duopoly with Tesco
- However with the competuitions and markets authority allowing the merger of Tesc and Booker, they are confident
Forms of purchase in mergers
- Cash - amount paid is clearly understood
- Also shareholder control is not reduced
- Raising large amounts of cash is difficult
- Possible t spread payments over a period. This weakens the attraction however
- Receipt allows taret shareholder to adhust ther portfolios without selling cost, but this creates a capital gains tax liability
Shares
- Avoids strain on cash position
- Dilution of shareholder control and EPS
- Need to ensure market value of business shares do not fall due to the takeoveer
Loan Capital
- Avoids cash load
No dilution of shareholder control
Incrases gearing and level of financial risk
Must ensure it is within borrowing limits
Who benefits?
Shareholders in the target business are usulally main benficiaries
In the bdding business, they usually have little to celebrate. Studies suggest in the long run share values decrease. Other studies suggest in the long ruun particular poor performance
Hostile takeover
Target firm rejcts to takeover proposal ad the bidding firm pursues anyway by contacting shareholders
Firms can buy shares on the open market
Managers
Senior managers are important stakeholders
Managers are usually beneficiaries as they will have greater status and incomes, however in target business it is less certain as they are vulnerable
-
Successful integration needs:
- Early planning
- Rapid integration
- Incentivising managers
-