Merger
Two existing firms can join together in two different ways. First, one firm may make a takeover bid for the other by offering to buy out the shareholders of the second firm. Managers of the victim firm will usually resist since they are likely to lose their jobs, but the shareholders will accept if the offer is sufficiently attractive. In contrast, a merger is the voluntary union of two companies where they think they will do better by amalgamating.
It is important to distinguish three types of merger. By horizontal merger we mean the union of two firms at the same production stage in the same industry, for example the merger of two steel producers or two car makers. By a vertical merger we mean the union of two firms at different production stages in the same industry, as when a car manufacturer merges with a steel producer.
Finally, there are conglomerate mergers, where the production activities of the two firms are essentially unrelated. For example, a tobacco manufacturer perceiving that the cigarette market is in long-term decline might join forces with a perfume company.
What do firms think they stand to gain by merging? A horizontal merger may allow exploitation of economies of scale. One large car factory may be better than two small ones. (Notice that this requires that each of the original companies were producing below minimum efficient scale.) In vertical mergers it is often claimed that there are important gains to coordination and planning. It may be easier to make long-term decisions about the best size and type of steel mill if a simultaneous decision is taken on the level of car production to which steel output forms an important input. Since conglomerate mergers involve companies with completely independent products, these mergers have only small opportunities for a direct reduction in production costs.
Two other factors are frequently mentioned as potential benefits of mergers. First, if one company has an inspired management team it may be more productive to allow this team to run both businesses. Managers of course are very fond of this explanation for mergers. Economists have tended to be more sceptical. Second, by pooling their financial resources, the merging companies may enjoy better credit-worthiness and access to cheaper borrowing, enabling them to take more risks and finance larger research projects. Managerial and financial gains could explain why mergers make sense even for firms producing completely distinct products.
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