Mergers and Diversification

MERGERS AND DIVERSIFICATION
What is a Merger?
A merger refers to an agreement in which two companies join together to form one
company. In other words, a merger is the combination of two companies into a single
legal entity. In this article, we will look at different types of mergers that companies can
undergo.
Types of Mergers
There are generally five different types of mergers:
1. Horizontal merger: A merger between companies that are in direct

competition with each other in terms of product lines and markets
2. Vertical merger: A merger between companies that are along the same supply
chain (e.g., a retail company in the auto parts industry merges with a company
that supplies raw materials for auto parts.)
3. Market-extension merger: A merger between companies in different markets
that sell similar products or services
4. Product-extension merger: A merger between companies in the same
markets that sell different but related products or services
5. Conglomerate merger: A merger between companies in unrelated business
activities (e.g., a clothing company buys a software company)
Horizontal Mergers
A horizontal merger is a merger between companies that directly compete with each
other. Horizontal mergers are done to increase market power (market share), further
utilize economies of scale, anxploit merger synergies.
For example, a famous example of a horizontal merger was between HP

(Hewlett-Packard) and Compaq in 2011. The successful merger between these two
companies created a global technology leader valued at over US$87 billion.
Vertical Mergers
A vertical merger is a merger between companies that operate along the
supply chain. Therefore, in contrast to a horizontal merger, a vertical merger is
the combination of companies along the production and distribution process
of a business. The rationale behind a vertical merger includes higher quality
control, better flow of information along the supply chain, and merger
synergies.
For example, a notable vertical merger happened between America Online

and Time Warner in 2000. The merger was considered a vertical merger due to
each company’s different operations in the supply chain – Time Warner
supplied information through CNN and Time Magazine while AOL distributed
information through the internet.
Market-Extension Mergers
A market-extension merger is a merger between companies that sell the same
products or services but operate in different markets. The goal of a market-extension
merger is to gain access to a larger market and thus a bigger client base/target market.
For example, RBC Centura’s merger with Eagle Bancshares Inc. in 2002 was a
market-extension merger that helped RBC with its growing operations in the North
American market. Eagle Bancshare owned Tucker Federal Bank, one of the biggest
banks in Atlanta, with over 250 workers and $1.1 billion in assets.
Product-Extension Mergers
A product-extension merger is a merger between companies that sell related products
or services and operate in the same market. By employing a product-extension merger,
the merged company is able to group their products together and gain access to more
consumers. It is important to note that the products and services of both companies
are not the same, but they are related. The key is that they utilize similar distribution
channels, common or related production processions, or supply chains.
For example, the merger between Mobilink Telecom Inc. and Broadcom is a
product-extension merger. The two companies operate in the electronics industry and
the resulting merger allowed the companies to combine technologies. The merger
enabled the combination of Mobilink’s 2G and 2.5G technologies with Broadcom’s
802.11, Bluetooth, and DSP products. Therefore, the two companies are able to sell
products that complement each other.
Conglomerate Mergers
A conglomerate merger is a merger between companies that are totally
unrelated. There are two types of conglomerate merger: pure and mixed.
 A pure conglomerate merger involves companies that are totally unrelated

and that operate in distinct markets.
 A mixed conglomerate merger involves companies that are looking to
expand product lines or target markets.
The biggest risk in a conglomerate merger is the immediate shift in business
operations resulting from the merger, as the two companies operate in completely
different markets and offer unrelated products/services.
For example, the merger between Walt Disney Company and the American
Broadcasting Company (ABC) was a conglomerate merger. Walt Disney Company
is an entertainment company while American Broadcasting company is a US
commercial broadcast television network (media and news company).
MEANING OF DIVERSIFICATION
Diversification is an act of an existing entity branching out into a new business
opportunity. This corporate strategy enables the entity to enter into a new market
segment which it does not already operate in. The decision to diversify can prove to be
a challenging decision for the entity as it can lead to extraordinary rewards with risks.
Some very famous success stories of diversification are General Electric and Disney.
However, the entry of Quaker oats into the fruit juice business, Snapple lead to a very
costly failure.
After knowing the meaning of diversification, we’ll see the reasons why companies opt
for the same.
WHY DO COMPANIES DIVERSIFY?
The following are the reasons why firms opt for diversification:
 For growth in business operations

 To ensure maximum utilization of the existing resources and capabilities
 To escape from unattractive industry environments
On gaining knowledge on the concept of diversification, let’s have a look at the

advantages and disadvantages of the same.
ADVANTAGES OF DIVERSIFICATION
The following are the advantages of diversification:
 As the economy changes, the spending patterns of the people change.

Diversification into a number of industries or product line can help create a balance for
the entity during these ups and downs.
 There will always be unpleasant surprises within a single investment. Being
diversified can help in balancing such surprises.
 Diversification helps to maximize the use of potentially underutilized resources.
 Certain industries may fall down for a specific time frame owing to economic
factors. Diversification provides movement away from activities which may be
declining.
DISADVANTAGES OF DIVERSIFICATION
The following are the disadvantages of diversification:
 Entities entirely involved in profit-making segments will enjoy profit

maximization. However, a diversified entity will lose out due to having limited
investment in the specific segment. Therefore, diversification limits the growth
opportunities for an entity.
 Diversifying into a new market segment will demand new skill sets. Lack of
expertise in the new field can prove to be a setback for the entity.
 A mismanaged diversification or excessive ambition can lead to a company over
expanding into too many new directions at the same time. In such a case, all old
and new sectors of the entity will suffer due to insufficient resources and lack of
attention.
 A widely diversified company will not be able to respond quickly to market
changes. The focus on the operations will be limited, thereby limiting the
innovation within the entity.
On understanding the advantages and disadvantages of diversification, we’ll see the
types of diversification strategies.
TYPES OF DIVERSIFICATION STRATEGIES

HORIZONTAL DIVERSIFICATION
This strategy of diversification refers to an entity offering new services or developing

new products that appeal to the firm’s current customer base. For example, a dairy
company producing cheese adds a new variety of cheese to its product line.
VERTICAL DIVERSIFICATION
This form of diversification takes place when a company goes back to a previous or
next stage of its production cycle. For example, a company involved in the
reconstruction of houses starts selling construction materials and paints. It may be
forward integration or backward integration.
CONCENTRIC DIVERSIFICATION
In this form of a diversification strategy, the entity introduces new products with an aim
to fully utilize the potential of the prevailing technologies and marketing system. For
example, a bakery making bread starts producing biscuits.
CONGLOMERATE DIVERSIFICATION
In this form of diversification, an entity launches new products or services that have no
relation to the current products or distribution channels. A firm may adopt this strategy
to appeal to an all-new group of customers. The high growth scope and return on
investment in a new market segment may prompt a company to take this option.

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MERGERS AND DIVERSIFICATION

1. Horizontal merger: A merger between companies that are in direct

For example, a famous example of a horizontal merger was between HP

For example, a notable vertical merger happened between America Online

 A pure conglomerate merger involves companies that are totally unrelated

WHY DO COMPANIES DIVERSIFY?

 For growth in business operations

On gaining knowledge on the concept of diversification, let’s have a look at the

 As the economy changes, the spending patterns of the people change.

The following are the disadvantages of diversification:

 Entities entirely involved in profit-making segments will enjoy profit

TYPES OF DIVERSIFICATION STRATEGIES

This strategy of diversification refers to an entity offering new services or developing

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