Motivations that Triggers M&A Transactions – 2

In our last article, we have seen two of the most common motivations that triggers an M&A transaction. One of them was the expectation of “growth”. Those who are willing to have a leap in their revenues or who are willing to set their sails to new geographies have this motivation in their minds. On the other hand, there are some companies which would like to increase their efficiency or to decrease their costs or even to reach financial resources easily. Their motivation to find a ab acquisition transaction is to create a “synergy” between two parties.

Now, let’s get going for two new motivation type and find out if you have motivated for an M&A transaction.

If a company expand its operations in an industry field other than its original one, it is called diversification. Actually, many ones who tried that regrated their efforts for trying that. Although economic principles more or less the same within all industry branches, dynamics of trade and production can be differ. With the absence of experience, it would be a shameful trial to expand in a different industry branch. 

However, some companies enjoy the prosperity of diversification very well. The best example can be General Electric (GE). Despite the brand name ends with “electric”, GE acquired many companies in different fields like insurance, financial services, medical supplies and even broadcasting.

At this point, the secret behind the success of GE should be underlined. The most important point that GE pay attention is that GE tries to acquire the industry leaders. That is to say first 3 companies in the respective industry. Researches show that secondary companies in an industry (which are 4th, 5th and 6th ones) are generally disadvantages in many ways to compete with industry leaders. In that sense, in case you would like to expand your business in a different industry, you should knock the doors of experts to have mouth-watering return. Also by this way, you will not need to give battle for the market of the respective industry.

Every market has its own life cycle. It emerges, grows and then dies. The best profitable times in a market is the emerging times. Once the life cycle touches the end point, profitability rates drops as there are too many actors working in the same room. Thus, even you are the industry leader, after some decades, you might miss the return rates of old times. Now think about this is happening in a market that you are not familiar with. In order to prevent such result, when investing in a different industry market, you need to have a solid exit strategy. Well, GE already understood the rules of the game so that experts of GE regularly check market conditions and in case there is an alarming one, GE sells its investments. 

A research that examined 1.500 M&A transactions in U.S.A between 1980 – 2010 shows that companies who diversifies their industry orientations announce 1,5% more profit than those who stick with a single industry.  Interestingly, the main reason of this seems to cause by increasing efficiency that arise after the acquisition. Researches shows that after the transaction, the expenses of those companies decreased between 1,8% and 2,6%. Well, since the result is good, nobody asked any question.

In some cases, two actors within the same industry can merge together. This is called horizontal integration. The most important factor in cases such this is that actors know each other very well so that they know they can cover their back for their vulnerabilities. Studies shows that after a merger with this motivation generally does not affect the quality of the product but creates a decrease in the cost side of the operations. Since the cost of product decrease, the new company will have the price advantage. Also it should also be underlined that when our two actors merged, the market power of the new company become better.

Market power or monopoly power is defined as the pricing power which let the company to define the price above the normal level of the market. Normally, prices are defined in a market equals to marginal costs. At least the science of economics tells us so. However, in case there is a monopolistic market, prices can be defined way above the marginal costs and the market leaders enjoy the easy money for a long time.

Although the main aim of the horizontal integration is not directly to create a monopolistic market, it also let in many cases to obtain pricing power beyond to create cost advantage.  Nonetheless, it is not that easy to merge two actors within the same market. There are lots of regulations and institution which can prevent such transaction. For example, in Turkey, there is so called Competition Authority that investigate M&A transactions in order to prevent a creation of monopolistic markets. Thus, in case you have the motivation of horizontal integration and find a company to merge with you need to analyse the effects of merger in detail to avoid any violations with regulations.

This week, we have seen two more motivation type. We have still way to go. In case you could not find the essence of your ideas in those motivation, wait a while. Next week, we will deal with two more motivation types in our new article. Maybe this time, we can hit the bull’s eye.