Economics Consideration of M and A

1. Purpose of M & A
Why does any enterprise resort to M & A? The theories which explain the reason for M & A can broadly be classified into two types.

One theory is based on the financial consideration. In this case, M & A takes place aiming at financial profits. This type of M & A explains the act from view point of owners and stock holders of the enterprise. Through this type of M & A higher efficiency of management is sought.

According to another theory, the M & A takes place in accordance with the management aims. This is a theory as seen from the view point of management. The management finds the expansion and growth very necessary for their own position and earnings, and they carry out the M & A.

2.Effect of M & A
One serious question which must come to everybody’s mind is why at all the enterprise should resort to growth from outside rather than the growth from inside, may it be the financial aim or management aim. What are the conditions under which the enterprise selects growth from outside rather than growth from inside.

In the case of internal growth, an enterprise has to bear all the expenses on various heads by its own. This includes the investment on equipment, research and development and human resource development. On the other hand, the growth from outside is the merger and acquisition of enterprise.
Let us try to understand the effect of M & A as compared to the growth from inside.

· Economy of scale
The first effect of the M & A which can be considered here is the economics of scale which is obtained through the expansion of enterprise. This is the remarkable characteristic in the case of horizontal integration. As a result of M & A, the cost such as sales cost and general management expenses reduce. Of course, this type of effect can be obtained by expanding the scales on the basis of growth from inside also. It is important to note that in the case of M & A, this effect can be achieved in a shorter period.

· Saving on investment cost
Normally, large amount of capital investment is required for starting any new operation. While comparing the capital requirement, in the case of growth from inside with that in the case of M & A, any enterprise shall resort to M & A, if the investment requirement in the case of latter is low.

This comparison can be explained properly through the theory of Tobin’s Q. The Q is a ratio of procurement cost in the existing enterprise to the cost of establishing new enterprise and it can be computed as given below : -
Q = Cost of procuring existing enterprise / Cost of establishing new enterprise
The growth from inside is selected when Q is more than one whereas M & A becomes the obvious choice if Q is less than one. In many case, Q becomes less than one and becomes possible to save the investment cost on the basis of M & A.

· Evading the friction due to entry into the market
Severe friction with the existing enterprises can always be expected in the case of entry into a new market irrespective of M & A of existing enterprise. Further, there are many cases when entry itself is not very easy because of restriction and loss against entry which requires permission or approval. Therefore, in the case of M & A of an enterprise, which is actively engaged in the said already, the entry into the market becomes very easy.

· Immediate raising of management resources
In the case of M & A, the management resources like information as well as the brand name, excellent manpower and technology required for expansion into new operations etc can be obtained in one go and in short duration without much efforts. It becomes possible to enter into the market in a short duration through M & A and there is no operation opportunity lost.

The development and accumulation of management resources require considerable amount of time and efforts in the case of growth from inside and one cannot avoid the loss of operation opportunity to some extent.

These were the major effects of M & A. Among these, the most significant effect of M & A is the “buying of time”. This factor gains particular importance in this age where prompt action is most important to meet the rapid changes in the environment.

3. Problems of M & A
The M & A has one big merit of possibility of buying the time, however, there are many problems also. Even in America, where M & A is very popular and is practiced very frequently, it is said that about half of the M & A cases end up in failure. Some of the problems related with M & A are listed below.

· Problems before the decision is made
The decision with regard to the merger and acquisition has to be taken in an extremely short period. Further, it is necessary to maintain a high level of secrecy. Therefore, there is a possibility of occurrence of a phenomenon of “Group Thinking”, where the decision making by the group may be diverted due to the group environment. As a result, there is possibility of wrong M & A, that too without any suspicion.

Moreover, the decision has to be made on the basis of limited information only. Therefore, M & A is extremely risky proposition in some cases.

· Problems from the management point of view
The organisational culture of one enterprise is different from that of the other and M & A always results in friction within the organisation. Therefore, it becomes difficult to accomplish the synergy, particularly the employees of the company which has been acquired or merged may have strong psychological resistance against the other company which is acquiring.

Further, it may not be necessarily possible to generate added value to justify the premium of operation even when M & A has been carried out successfully.

The management, particularly after the merger and acquisition is an extremely difficult problem. However, whatever may be the problems, there is probably not going to be major change in the concept of merger and acquisition, which shall remain one of the important strategies for the future.