ONLINE CHAPTERSAnother economy of scale can occur through workforce and related reductions after two companies
are merged. For example, the combined company only needs one CFO, one billing department and one
branch on the corner of Broad and Main Streets; therefore, they can reduce workforce and branches,
ultimately cutting costs. In general, the CEO and senior executive team of a company are the most highly
paid staff members. Executive pay scales can be so far skewed from the rest of the workforce that simply
eliminating one senior executive team or head office can produce substantial merger cost synergies.
Obviously, senior management are well aware of this, and thus often fight to avoid acquisition, or to
ensure that they have control in a merger situation.
Economies of scope also create value because of increased size, in this case when a company produces
several different goods or internally houses several aspects of the supply chain. For example, a huge
company like Johnson and Johnson can afford to have an in-house graphics team at a cost that is lower
than if each division individually contracted out graphics work.
Revenue enhancements can lead to synergistic gains when two combined business entities sell more
products than they could sell separately. This revenue synergy is often the result of resource complementarities,
which occur when a company with a particular operating expertise merges with a company with
different strengths, to create a company that has expertise in multiple areas. A good example of such a
complementarity is the 2010 merger of Disney and Marvel. Benefits of the merger include combining
Marvel’s deep bench of characters with Disney’s well-established distribution channels (for movies and
collectibles). Cross-selling opportunities can also arise when an acquisition provides a company with
access to markets in a new geography or a new demographic.
Cost reductions are often fairly straightforward to predict and document, and in fact, companies
often realise nearly all of the predicted cost synergies. In contrast, revenue enhancements are much
harder to achieve. The Finance in practice box on page 727 describes a McKinsey study that documents
that fewer than half of mergers achieve hoped-for revenue synergies. As has been mentioned, it is also
important to verify that a formal merger (as opposed to a joint venture, for example) is necessary to
achieve the hoped-for synergies.Market Position
Mergers often occur when a company attempts to solidify or improve its position in its industry. For
example, between 2010 and 2012, Metcash Food and Grocery, the suppliers of the IGA and Super
IGA network of supermarkets, embarked on a series of acquisitions to purchase the former Franklins
supermarket stores. Its objective was to strengthen and protect its market position in response to the
growing threat from Woolworths and Coles supermarket chains following the collapse of the Franklins
chain. A similar phenomenon can occur in slow-growth or unprofitable industries. In this case, an industry
often begins to consolidate, leaving fewer companies to compete over shrinking profits. Managers often
take the perspective, ‘Consolidate or be consolidated.’ In the US in recent years, the drugstore and
domestic airline industries have consolidated. In Australia, substantial consolidation has been taking
place in the financial planning industry. The introduction of increased regulation and uncertainty
about further regulatory change have made it difficult for many small financial planning practices to
remain competitive given their increased compliance burden. Thus, many are merging in order to share
compliance costs, and others are selling their client lists to larger players at discounted values and exiting
the industry. Industry consolidators such as IOOF Holdings Limited (listed on the ASX as IFL) and
SFG Australia Limited (listed on the ASX as SFW) have been able to take advantage of these conditions
to increase their industry footprints substantially by acquiring smaller financial planning dealer groups
(which in turn comprise a large number of financial planning practices).economies of scope
Value-creating benefits
of increased breadth of
operations for merged
companies
resource
complementarities
A company with a particular
operating expertise merges
with a company with another
operating strength to create a
company that has expertise in
multiple areas