Concepts and Procedures for global vertical merger
Advantages and Disadvantages
Types of Vertical mergers
Case Study --
Nineteenth century Scottish-American steel tycoon Andrew Carnegie introduced the concept and use of vertical integration.
What Does Vertical Merger Mean?
Vertical integration means that the assets that were previously held by two firms are combined into a single firm.
The result is either joint ownership or the sale of one firm’s assets to the other. Vertical integration means that the assets that were previously held by two firms are combined into a single firm.
The result is either joint ownership or the sale of one firm’s assets to the other.
Benefits of merger Diversification of product and service offerings Increase in plant capacity Larger market share Utilization of operational expertise and research and development (R&D) Reduction of financial risk
Why do mergers fail ? Lack of human integration Mismanagement of cultural issues Lack of communication
Vertical mergers involve a manufacturer forming a partnership with a distributor.
Companies to compete with the newly merged company becomes hard.
Distributor no longer has to pay the supplier for material .
Creating Barriers in the Market
vertical mergers can foreclose rivals from access to needed inputs in the market
raise prices in the market
reduce the quality of product in the market.
These effects can definitely make it difficult for new businesses to enter the market.
Motivation for Mergers
To diversify the areas of activity and thereby to reduce business risks;
To achieve optimum size so as to reap the benefits of economy of scale;
To reduce the duplicate expenses and thereby to improve the profitability;
To serve the customer better;
To have cohesiveness in control of the organisation;
To grow without any gestation period;
Inorganic growth is believed to be much faster compared to organic growth.
Takeover might be : Hostile Takeover A takeover attempt that is strongly resisted by the target firm Friendly Takeover Target company's management and board of directors agree to a merger or acquisition by another company.
Example of Vertical Merger Time Warner Incorporated, a major cable operation, and the Turner Corporation, which produces CNN, TBS, and other programming. Pixar-Disney Merger
Facts & Figures on Mergers
Worldwide mergers and acquisitions in the first quarter of 2011 exceeded $789 billion.
Combined with $870 billion in Q4 2010 that amounts to over $1.2 trillion over 6 months.
1 Source: Thomson Financial Services
KNIGHTS AND SQUIRES In the case of a hostile takeover, the firm making the bid can be referred to as a 'black knight'. ‘White knight' is a firm that may enter the fray as a 'friendly' bidder. A 'grey knight' is a third firm that is not welcomed by the 'victim', seeking to exploit the situation to their own advantage. ‘Yellow knight' is a firm who originally seeks to launch a hostile takeover bid but then moderates its stance and negotiates on the basis of a merger. ‘White squires‘ is a firm which may not be big enough to be able to take control of another firm but may well seek to buy into the 'victim' firm to prevent the 'black knight' from being able to achieve its takeover plans.
Global Procedures for Vertical Mergers
Laws vary with countries Most of the developed countries of the world have some form of merger control. Cross border transactions will be subject to the multiple jurisdictions of the home countries of bidders andtargets. The laws differ across the countries and among the organizations. The laws also govern the structure of the merger going to take place. In India, the Companies Act of 1956 is used as a regulation by the companies.
Key Issues Vertical merger may be anti-competitive.
It may harm the competition by making it difficult for them to gain access to important raw material/component of a product.
It may gain control over some channel of distribution.
The organization may start to monopolize the market and dictate their own terms including raising the prices.
Antitrust !! Staples wanted to takeover the stationery shops in India !!!
Clayton Antitrust Act U.S. antitrust law regime that seeks to prevent anticompetitive practices. Enforced by the Federal Trade Commission.
Gives the FTC power to prevent firms from engaging in harmful business practices.
Made it illegal for a company to acquire the stock of another company if competition could be adversely affected. Gave the FTC the power to block asset purchases as well as stock purchases
The Global Guidelines
The Process Top management commits towards merger. Search for a merger partner Negotiate with several shortlisted companies suited to be merger partner for settling terms of merger. Initiate the legal procedures in accordance to the government laws.
Global guidelines for a merger The scheme of merger should be prepared by the companies, which have arrived at a consensus to merge. Approval of Board of Directors for the scheme. Approval of the scheme by specialized financial institutions/banks/trustees for debenture holders. Intimation to Stock Exchange about proposed merger. Application to Court for directions for meeting of creditors/members.
Advertisement of the notice of members meeting. Holding the shareholders general meeting and passing the resolutions. Submission of report of the chairman of the general meeting to Court. Submission of Joint petition to court for sanctioning the scheme Transfer of the assets and liabilities. Allotment of shares to shareholders of transferor company Other Post merger obligations.
Tender Offer Process Approval by 50 percent or more of the shareholders of the target firm gives control to the bidder. After the bidder has obtained control, the terms of the transaction may be “written down” on the minority. By law, shareholders of a target firm have a 20-day waiting period before they are required to vote. If another bidder competes with the first, the target shareholders must have an additional 10 business days to evaluate the new offer.
Steps The parent forms a wholly/partially owned subsidiary. The target transfers its stock to the parent. The target’s assets and liabilities are transferred to the subsidiary. The merger consideration (parent stock) is paid to the target shareholders for all the target shares. All the target shares are canceled. The target’s stock is wholly owned by the parent.
Common reasons for vertical integration Increased control over quality of supplies or the way the product is marketed Better information about supplies or markets Greater opportunities for differentiation through coordinated effort Opportunity to make greater profits by performing another function in the vertical supply chain
Advantages of a vertical integration : Economies of Scale Large scale production that lead to lower unit costs Control of Markets Gain some form of monopoly power Control supply Secure outlets Cost Lower buying cost of material Lower distribution cost Efficiency Improve technical, productive or allocative efficiency
Contd.. Shareholder Value Improve the value of the overall business for shareholders Entry barriers to new competitors if the firm can gain sole access to a scarce resource Protects product quality through control of input quality and distribution and service of outputs Improves internal scheduling (e.g., JIT inventory systems) responses to changes in demand
Disadvantages of vertical integration Cost disadvantages of internal supply purchasing Increase overhead and capital expenditure low efficiencies due to lack of supplier competition. Limits flexibility In responding to changes in technology, customer preferences, etc. Strategic differences Increases management difficulty Lack of expertise in diversification efforts
Contd.. Narrows range of choices available to firm for investment May reduce innovation Established distribution channels may be adversely affected Additional administrative costs
ISSUES WHILE DECIDING WHETHER TO VERTICALLY INTEGRATE AND TO WHAT EXTENT ? Following issues must be consider
Are there Economies of scale
Are there any market external factors
Is there any need to pursue any monopoly power??
One of the earliest, largest and most famous examples of vertical integration was the Carnegie Steel company.
The company controlled not only the mills where the steel was made, but also the mines where the iron ore was extracted, the coal mines that supplied the coal, the ships that transported the iron ore and the railroads that transported the coal to the factory, the coke ovens where the coal was cooked, etc.
The company also focused heavily on developing talent internally from the bottom up, rather than importing it from other companies.
Later on, Carnegie even established an institute of higher learning to teach the steel processes to the next generation
Vertical Mergers can be classified as
A company tends toward forward vertical integration when it controls distribution centers and retailers where its products are sold.
A company exhibits backward vertical integration when it controls subsidiaries that produce some of the inputs used in the production of its products. Example: Tata Motors acquires TrilixSrl (Italian design house)
Balanced vertical integration means a firm controls all of these components, from raw materials to final delivery.
Example :American Apparel
A good example of forward integration is when a farmer sells his/her crops at the local market rather than to a distribution center.
Example of backward integration
Tata Motors Ltd said on Monday that it had acquired an 80% stake in TrilixSrl, an Italian design and engineering firm for €1.85 million (Rs. 11.29 crore).
The acquisition is in line with the company’s objective to enhance its styling and design capabilities to global standards.
The remaining stake in Trilix is held by its promoters Federico Muzio and JustynNorek.
With a turnover of €4 million and net profit of €2,50,000, the company offers design and engineering services in the automotive sector.
Since it is controlling its subsidiary that produces some input.so it is backward integration.
According to analysts, the acquisition is not a very significant one in terms of the deal size, but it will help Tata Motors enhance its design capabilities. However, since the company is looking forward to some new launches and re-launches, it may be in a positive direction.
Example of Balanced Vertical Integration American Apparel
American Apparel is a fashion retailer and manufacturer that actually advertises itself as a vertically integrated industrial company.
The brand is based in downtown Los Angeles , where from a single building they control the dyeing, finishing, designing, sewing, cutting, marketing and distribution of the company's product.Thecompany shoots and distributes its own advertisements, often using its own employees as subjects.[
It also owns and operates each of its retail locations.
According to the management, the vertically integrated model allows the company to design, cut, distribute and sell an item globally in the span of a week.
Since the company controls both the production and distribution of its product, it is an example of a balanced vertically integrated corporation.
The original founder DovCharney has remained the majority shareholder and CEO.
ROLE OF THE HR DEPARTMENT IN VERTICAL MERGER
Developing key strategies for a company’s activities.
Managing the soft due diligence activity.
Providing input into managing the process of change
Advising top management on the merged company’s new organizational structure.
Overseeing the communications
Managing the learning processes
Re-casting the HR department itself
Identifying and embracing new rolesfor the HR leader
Identifying and developing new competencies
The strategic contribution of HR as consisting of the “Five P’s”: Philosophy, Policies, Programs, Practices, and Processes. Conclusion Vertical merger success entirely depends on the people who drive the Business, their ability to Execute, Creativity, and Innovation. It is of utmost importance to involve HR Professionals in Vertical merger discussions as it has an impact on key people issues.
VERTICAL MERGERS Time Warner & AOL (America Online Inc.)
TIME WARNER :HISTORY
Warner Brothers has been formally registered on1923.
Warner Brothers made a number of well-known Classic Films, such as Casablanca and a number of Hitchcock thrillers.
Warner Brothers also began to acquire many record labels. (associated with the marketing of music recordings and music videos).
In 1989, Warner Brothers merged with the publishing house Time to Time Warner for about US$14 Billion
Transformed it into a multi-media company consisting of motion pictures, television production and distribution, studio facilities , magazine publishing and many others.
In order to increase its product portfolio Time Warner acquired Turner Broadcasting System in 1996 and hence became the second largest cable television network.
AOL (America Online Inc.) : HISTORY
AOL was founded in 1985 under the name Quantum Computer Systems
AOL was the first On-line Service requiring the use of proprietary software (computer software licensed under exclusive legal right of its owner)
AOL also provided Internet access to the World Wide Web
Reasons For The MERGER TIME WARNER AOL Effective way to distribute its contents via Online Channels Combination of two global players - Strengthening its international position High-quality contents on the internet - translates into Revenue Growth. To remain competitive it needed an immediate injection into the Internet. Strategy for moving its customers forward into the world of high-speed "Broadband” Increase the Revenues at the three major areas : Subscriptions, Advertising and E-commerce and Content
On January of 2001, the United States largest internet provider, America Online, merged with the nation’s second largest cable provider to create a media giant
Time Warner's major possessions included the cable networks HBO and CNN, the Warner Brother’s movie and music operations, and Time magazine, while AOL provided internet service to approximately 26 million customers
Terms requires that AOL’s instant messenger be opened to other internet service providers via Time Warner’s cable lines.
Increasing Profitability Through Vertical Integration Building barriers to entry Facilitating investments in specialized assets Protecting product quality Improved scheduling
The Growth of Firms External Growth: Through amalgamation, merger or takeover (acquisitions) Mergers – agreed amalgamation between two firms
Behavioural Objectives Modern firms have to attempt to match competing stakeholder needs: Shareholders Employees Consumers Suppliers Government Local communities Environment
Behavioural Objectives Firms may have to balance out their responsibilities: ‘Fat cat pay’ Management rewards – bonuses, etc. Social and environmental audits Employee welfare Meeting consumer needs Paying suppliers on time Satisfying shareholders and ‘The City’ about its policies, plans and actions
Diminished Enthusiasm for Vertical Integration Inability to achieve expected returns Lack of proficiency in diversification efforts Conflicting goals of competing businesses Decline of capitation payments Increased demands of core business Substantial changes in payer environment for health plans, hospitals, and post acute services (BBA of 1997) Reduced resources for investment