E) Horizontal Mergers and Strategic Alliance

• Merger = Integration = consolidation when two

different equal firms combined together and form
new firm in which the original firms maintain their
share
• A takeover = acquisition the purchase of a smaller
company by a much larger one so that the acquired
company share is no longer hold by the sellers
• Firms combined together to be better firm in which
economies of scale is boosted, achieve greater sales
revenue, increase market share, broadened
diversification, and increased tax efficiency.
• Types of merger
– Horizontal - a merger between companies with
similar products
– vertical - a merger that consolidates the supply
line of a product.
– Conglomerate - a merger between companies
who offer diverse products/services
– Concentric - a merger between companies who
have similar customers with different products.
 a) Horizontal Merger (Integration)
• Motives
– Profit maximizing motives and
– Non profit maximizing motives
1) Profit maximizing motives through
A) Market power
• In oligopoly market there is high interdependence and
uncertainty
• To minimize uncertainty collusion is one way which is
illegal
• Where collusion is difficult horizontal merger (takeover)
is viable strategy
• This gives market power to the merged firms
• Factors that influence the degree of market power
following a merger:
– Degree of seller concentration: if seller concentration
significantly increases government may not permit
– Productive capacity of rivals: if the merged firm
increases price due to the new market power, and if
other firms have much capacity to supply at the lower
cost the merged firm’s power decreases
– The ease of entry: difficult entry more power
– Market demand: low price elasticity high market power
– The level of buyer concentration: large scale buyers
decrease market power
– Acquisition of a failing firm: acquiring failing firm
increases power due to decrease in firm numbers
B) Cost savings
• Merger saves cost than internal expansion.
• What are the sources of cost saving?
1) Rationalization: producing in the low cost firm
2) Economies of scale: mass production decreases
price
3) Research and development: they share know
how and protect their technology from diffusion
4) Purchasing economies: discount on purchased
input and easy access of loan
5) Productive inefficiency and organizational slack:
reorganization of the firms improve efficiency
6) Merger Specific Gains (Synergies)
– Coordinating joint operations of collusion is costly
than merger
– Sharing complementary skills and patents
– Improved interoperability: making their products
compatible
– Network configuration: if the two companies use
similar infrastructure they can share one
2) Non-profit-maximizing Motives for Horizontal
Mergers
1) Managerial Discretion: the manager may have
different objective (growth objective) and use
the merger/ acquisition strategy
2) Market for Corporate Control: well performing
managers takeover the low performing managers
3) The Capital Redeployment Hypothesis: if merged
information flows easily so resource redeployed
from the poorly performance manager to others.
Market cannot get such information easily to
give more loan to the best performer
 b) Strategic (Corporate) Alliances
• Inter-firm alliance is an incomplete contract,
involving an agreement to cooperate in which
there is opportunistic behaviour
• It is commonly seen as a viable alternative to
merger due to
– regulatory or political opposition
– high cost of integration
– The problem of irreversibility
• There are different level of alliance
F) Vertical Integration and Vertical Restraint
• Vertical integration is with firms operating at
different stages of the same production process.
• Why firms integrate vertically?
– the desire to secure enhanced market power;
– the technological benefits of linking successive stages of
production;
– the reduction in risk and uncertainty associated with the
supply of inputs or the distribution of a firm’s finished
product; and
– the avoidance of taxes or price controls.
• Vertical Disintegration is important when the market is
too large
• Agency/Vertical relationships: is a looser nature than
full-scale vertical integration
• Vertical Restraints: are competition restrictions in
agreements between firms at different stages of the
production and distribution process.
 Motives for Vertical Integration:
A) Enhancement of Market Power and restrict
competition
B) Cost Savings
– Transaction cost saving
– Complimentary technologies save production
cost
– Decreases cost of collecting information:
uncertainty -- limited info. –bounded rationality
– Assured steady supply of inputs
– Externalities – to keep ones technology secret
- Complexity: complex technical and legal vertical
relationships may be eased and costs of contracts
decrease
- It decreases contractual moral hazard problem
- Avoidance of tax or price controls
- Asset specificity: it minimizes the uncertainty
related to custom-made products for specific
clients. (types of asset specificities)
o Site specificity
o Physical asset specificity (plant)
o Human asset specificity.
o Dedicated assets (large inventory)
 Agency and Vertical Relationships
• Is vertical relationship based on non-exclusive
contract
• Advantages include
– The firms remain independence
– They avoid integration costs
– The avoid the irreversibility problem
• Examples
– Franchising contract
– Informal networks of independent firms establish
non-exclusive contracts
A) Franchise Agreements
• a vertical relationship between two independent firms: a
franchisor and a franchisee
• In the contract things like set-up fees, license fees,
royalties or other payments, prices to be charged,
services offered, location and marketing effort are covered
• Types of franchise agreements
– The business format franchise : the entire business format is
copied
– The product or trademark franchise: produce the product with
the same trade mark using its own format
– The producer-to-wholesaler franchise and wholesaler-to-
retailer franchise
B) Informal Networks
• For example, upstream firms might train staff
in downstream firms, provide technical
expertise, and customize their products in
order to meet specific requirements of buyers.
 Vertical Restraints
• Vertical Restraints are competition restrictions
in agreements between firms at different stages
of the production and distribution process.
• Types of vertical restraints
– Resale price maintenance -- up stream firm controls
resale price of the downstream firm
– Foreclosure -- refusing to supply a downstream
firm, or to purchase from an upstream firm.
– Territorial exclusivity: geographic foreclosure
– Slotting allowances: place their products in
prominent positions.
– Quantity-dependent pricing:
 Motives for Vertical Restraints
a. Enhancement of Market Power methods
 Price or profit squeeze: selling intermediate
goods at high price to nonintegrated firm and
using it at low cost internally
 Increase in final prices and deterioration of
service: prohibit the downstream distributers of
selling other brand products and increasing price
 Increased opportunities for collusion: strong
restraint leads to collusion
 Raising Entrants’ Costs: raising sunk cost, denying
supply of input, etc
b) Cost savings
• It is through internalizing externality and
solving the problem of free riding
 G) Diversification
• It is producing multiple products
• Large diversified firms which operate in many
sectors of the economy are often referred to
as conglomerates.
• Types of diversification
1) Product Extension: expanding to related
products (mango juice, orange juice etc)
2) Market extension: expanding to new location
3) Pure diversification (conglomerates):
expanding to unrelated goods
• Diversification strategy is implemented in two
ways
1) Through internally generated expansion
2) Through merger and acquisition
Motives for Diversification
o Enhancement of market power through
 Cross-subsidization - predatory competition
 Reciprocity and tying
o Cost savings through
 through the realization of economies of scope;
 by reducing risk and uncertainty; and,
 by reducing the firm’s tax exposure.
o Reduction of transaction costs
– the conglomerate as an internal capital market –
capital redeployment between branches
– the conglomerate as a vehicle for the exploitation
of specific assets like technologies, trade secrets,
brand loyalty, managerial experience and
expertise
– the ability of a conglomerate to deliver services -
o Managerial motives for diversification which
growth
 The Multinational Enterprise
• Is the FDI
• Its benefits
– access to cheap resources,
– reduction of transport costs,
– reduction of tax exposure, and
– financial inducements (incentives) from
government.
 CH-4
Competition Policy and Law
• Policy: policy is what government does to achieve
social benefit
– Economic concept
– In the name of the people
– Enhance competition
• Law: law is principles that bring justice to the society
– Legal concept
– for people
– Punish unfair competition
• Competition policy aims at fighting monopolies and
thus preserving free competition
• It has two main objectives
1) Protecting consumer interest (through
competition diverse products at lower cost)
2) Stimulating efficiency
 Productive efficiency
 Economic Efficiency
 Allocative efficiency
 perfect competition and natural monopoly are
efficient markets
 Competition policy deals with
 Monopoly/ competition
 restrictive practices,
 merger and
 unfair competition
• Two types of competition
Fair practices: it is competition through means such
as
– producing quality goods,
– becoming cost efficient,
– adopting the best technology,
– investing in research and development oriented activities.
Unfair practices: unfair competition involves the
adoption of restrictive business practices such as
 predatory pricing,
 exclusive dealing,
 forming cartels
• Thus, laws and policies are needed to regulate
the unfair competition
• Competition law is also referred to as antitrust
or antimonopoly law or restrictive business
legislation.
• It takes corrective measures on
– abused monopoly,
– restrictive practices,
– merger and
– unfair competitions