When Do Mergers Work?


Mergers of big companies many times are depicted on TV as a positive thing, a way for both companies to move up in the world and prosper. Other times they are shown as a strategic play when one company is floundering and another swoops in to save them. In this case the company that is bought may do better but the buyer rarely thrives.  Mergers and Acquisitions are a huge part of the corporate world with entire departments of companies and entire consulting agencies dedicated to these actions. At first glance mergers may seem like a good idea but they do not always work out favorably for the companies and their stockholders. Actually, many of them are profit losing for both companies. More than half of major corporate mergers end in failure or at least decrease the overall value of the companies. It is important that interests between shareholders and the owners of separate companies align.

A common misconceptions of why and when a merger may work? The theory of economies of scale guarantees success. Economies of scale explain how mergers would work if all other parts of the situation are handled correctly or there are certain aspects that can be explained directly through this notion. For example, when advertising is a large share of the costs for both companies then maybe a merger can be good to cut the advertising costs in half and have sales go up. The idea of merging to gain market power? Usually results in the opposite.

So when might a merger be good? One idea is when you are merging upstream or downstream in an industry. Additionally, mergers are more likely to succeed when companies buy businesses they know something about and will be invested in the product. Undoubtedly it is important to be clear about the logic of the deal. When a merger is done out of fear of say, contracting markets or uncertainties of technological change, there lies the problem. There is also the issue of copycat mergers. Disney and Pixar is often lauded as one of the more successful mergers in recent history. In 2006 Disney bought Pixar for $7.4 billion. While both companies may have had to deal with strained relations at first they were all working for the same set of shareholders and have both prospered under their new structure.  Overall this merger made sense as their outlooks aligned well and their strengths complemented each other. However, Disney and Pixar are the exception not the rule.


5 thoughts on “When Do Mergers Work?

  1. Too often mergers occur because a merger can increase stock price in the short run and increase the amount of press management receives. Theoretically management’s goal is to increase profit but more often than not managers are more concerned about bonuses and stock price, which means personal motivation can be the driving force behind a merger. While mergers can be useful, when it is done for reasons listed above it can lead to large losses and an inefficient management structure. In addition, companies need to merge with firms that are related to their area of focus. Acquisitions and mergers in a product line not central to a company’s product line often fail.

  2. What I find interesting is that spin-offs tend to fare better than mergers. When a public company splits into two separate, public entities, both the parent company and the spin-off company, on average, beat the market in the first two years following the action, with spin-offs faring slightly better. While mergers can often result in a lower shareholder value than previous, it seems that the opposite holds true, as spin-offs and parent companies create a higher shareholder value than the previous entity alone.

    • It makes sense. Decentralization of decision making leads to the least negative externality by policies of misfit. Additionally, spin-offs create competition and new companies get the same press coverage as merging companies. An average consumer might assume a spin-off company is spinning-off because it has more to offer independently, which could increase it’s sales. All the positives of merging (excluding economies of scale), and none of the negatives.

  3. This brings to mind the proposed acquisition of Instagram by Facebook. When Facebook offered to buy the company, they set the value at three billion dollars in November of 2013. Evan Spiegel (Snapchat’s head honcho) intelligently declined the offer. As of August 2014 the company was valued at over 10 billion dollars. This exponential increase is very attractive to larger companies like Facebook; they could have made 7 billion by just buying and selling less than a year later.

  4. Remember that economies of scale may be reaped in full at sizes far below that of the pre-merger firms. In that case diseconomies dominate.
    Even when there are potential gains – Daimler and Chrysler – firms have to be able to mesh their organizations. In practice that is not a trivial task. The value of tech companies may lie in their development team; if that’s broken up, what’s left are talented individuals, but not a functioning operation.
    Downstream/upstream can go wrong. In the auto industry the parts aftermarket looks attractive but the challenge of actually running retain rather than manufacturing pushed Dana into bankruptcy.

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