Entering a Merger and Organizational

Entering a Merger and Organizational

From the scenario for Katrina’s Candies, examine the major implications for firms entering into a merger. Explain the criteria the U.S. Department of Justice and the Federal Trade Commission would follow when deciding on whether or not to approve a proposed merger.

ECO550 Week 8 Scenario Script: Contracting, Governance, and Organizational Form
Slide # Scene # Narrations
Slide 1 Scene 1
An older cottage style family run business (Katrina’s Candies)

Slide 2 Scene 2
Conference room, weekly meeting Ken Sanders leading the meeting of Herb, Gigi, Renee, Maria.

Ken reports he’s considering merging with another company. Those present consider how the merger might transform Katrina’s Candies if the companies merge.

Each team member presents information about “mergers. Herb then does a presentation on market changes.
Ken: Good afternoon everyone! Thanks for responding in such short-notice to meet today. I have important information to share with you today, so let’s begin.

For the past seven weeks each of you has been engrossed in completing tasks associated with the plan to expand Katrina’s Candies into the international chocolate candy market. While you were responding to your assignments, I have been considering the possibility of merging with another company. Today I want to share the merger idea and get the team’s input.

Gigi: Ken, are you saying we are not going to expand Katrina’s Candies?

Ken: No, Gigi. I’m saying that as an alternative to expanding via capital investment, our company should consider a merger as a viable expansionary alternative. I like to think of merging with another company as a form of expansion!

Gigi: So, let me get this straight; mergers are a form of expansion?

Ken: Yes, a merger is an expansion since the resulting combined firms is larger than the independent firms. Therefore, if Katrina’s Candies were to merge, the result would be a larger company. At least that would be our goal, a larger post-merger Katrina’s Candies.

Renee: Does a merger have the same advantages for Katrina as an expansion? What about the merger advantages over a physical expansion? I seem to have quite a few questions. (Laughter)

Ken: Well a merger could be better than an expansion. For one thing a merger means immediate penetration of an existing market. In an existing market, we would not have to focus on developing demand for our sugar-free-chocolates; or any other product. Also, depending upon the location of the company involved in the merger, manufacturing resources could require smaller outlays than the cost of enlarging our existing physical plant.

Maria: How much cost savings is there when firms merge? Am I asking the right question?

Ken: Yes, Maria, you are asking the right question. There are other questions we need to consider, as well. I had a consulting firm make a short presentation overviewing a few issues we need to consider as we evaluate the merger option. Here, let’s see what the consulting firm had to say.
Slide 3 Scene 3
Interaction Slide
Ipad will be showcasing the video:
• Mergers and Acquisitions: The world’s best lecture tutorial in a nutshell.
o http://www.youtube.com/watch?v=J-t6zD5G4bk

Slide 4 Scene 4
Ken, Gigi, Renee, Maria and Herb in the Conference room
After viewing the video, still in the conference room, Ken gives the team an assignment.
Ken: I know each of you probably has important thoughts about my proposal to consider merging Katrina’s and thoughts about the consultants’ advice. I would like to hear your thoughts. But before you share your thoughts, I want you to go back to your respective offices, reflect, and then return in two days for a discussion.

Use the time between now and our next meeting to gather information about mergers and then be ready to share information.

Gigi: Any particular areas we need to concentrate on, Ken?

Ken: Not necessarily. However, to avoid duplication of efforts, the team could organize its efforts according to areas of expertise. Gigi, how about you focus on management issues; Renee and Maria, could you two concentrate on financial aspects, and Herb, could you provide us with some background information on the different types of mergers. Does this work for everyone?

Gigi: Yes!

Renee: Yes!

Maria: Yes!

Herb: Yes!

Ken: Okay, we will meet here in two days at the same time. Clear your schedules for this meeting; we’ll meet until we arrive at a consensus for this issue.

Slide 5 Scene 5
Two days later, Ken and the entire team are back in the conference room. Ken starts the meeting.

Show the consultants advice on screen
• Merge only if the merger generates “incremental value” of 50 percent or more.
• Ignore adviser’s advice.
• Look for revenue synergies.
• Create an implementation plan as soon as possible.
• Leave a margin for error. Ken: Okay, the floor is open for discussion about the proposal to merge Katrina’s Candies instead of expanding in the traditional way. As a reminder, here’s a summary of the advice the consultants gave us.

Herb: Thanks for showing us this Ken. It is very helpful to see this prior to making our decisions.

Ken: You’re welcome! I’m almost afraid to follow the consultants’ advice because of their second suggestion “don’t listen to advisers”! (Laughter) Who would like to begin?

Gigi: Herb is going to start us off with some background information about mergers then he will provide us with some basic information about some different types of mergers.

Herb: Thanks, Gigi. I started my research by searching news and financial websites for merger basics. I learned that some very large firms have used mergers to expand their firms. Here’s a list of the sources I consulted. There were lots more, but the one’s I selected describe current merger trends.

Slide 6 Scene 6
Interaction Slide
Slide will have several links to webpages that support Ken’s findings.
• Mergers and Acquisitions — The 10 Biggest Deals in 2013.
o http://investorplace.com/2013/12/mergers-and-acquisitions-biggest-deals-2013/#.UtLKqNJDuAg
• Cineworld merger widens vision as Europe’s second biggest cinema chain.
o http://www.theguardian.com/business/2014/jan/10/cineworld-merger-europe-second-biggest-cinema-chain
• Cross-border mergers and acquisitions deals soared in 2013.
o http://www.haaretz.com/business/.premium-1.567841
• Institute of Mergers, Acquisitions and Alliances (IMAA)
o http://imaa-institute.org/statistics-mergers-acquisitions.html

Slide 7 Scene 7
Herb and the rest of the team are in the conference room. Herb then describes the information he learned mergers from each of the four sources
Show chart showing worldwide mergers from the IMAA web link

Show chart showing China’s mergers

Show prepared chart of Types of Mergers
Herb: As indicated, I-M-A-A data shows decreases in merger behavior worldwide since 2007. I think these declines are consistent with the global economic slowdown that impacted world economies. However, there are some exceptions such as China, which from 1993 to 2013 data shows a generally upward trend in merger activity. Overall, although the numbers are lower in 2013, all news sources are reporting an upward trend in merger and acquisition activities.

Gigi: Any questions about this part of the information Herb presented before he moves on to part two?

Ken: Can we see the data for China’s mergers? I’m just a bit curious to know what’s occurring there.

Herb: Sure thing Ken! Here’s China’s chart.

Herb: You can see the difference between China’s mergers and acquisitions trends along with the worldwide trend showing an increase throughout the twenty-year period.

Ken: These statistics indicate we might want to look for a Chinese company to merge with Katrina’s Candies. Very interesting! Okay, Herb you can continue with your presentation.

Herb: After reviewing information on merger trends, I wanted to know exactly what it meant to “merge” two companies. I learned there are several types of mergers and here is a list I formed.
Slide 8 Scene 8
Herb and the rest of the team are in the conference room. Herb then describes the information he learned mergers from each of the four sources.

Gigi then shares her findings about mergers.
Herb: Let me now briefly explain each type of merger. When companies from different industries merge, the result is a “conglomerate.” The purpose of this type of merger is for the merging companies to “share knowledge.” In its purest form, conglomerate firms have nothing in common. However, in some instances the merger creates a mixed conglomerate meaning the firms have something in common.

When companies within the same industry merge to supply the same good or service, it’s called a horizontal merger. According to the information I found, horizontal mergers occur in industries where there are only a few firms.

Product extension is another type of merger. In the case of this type of merger, firms want to get a larger share of consumers. Keep in mind that post merger profits should be higher for the merged firms.

Next, we have market extension mergers, which occur when firms want to expand their market.

Lastly, we have vertical mergers, which involve one company merging with another company that supplies inputs to the production process. Vertical integrations tend to happen when a firm experiences problems in either supply chain or distribution process. Vertical integration can also lead to cost savings, depending upon the proximity between merging firms.

Ken: So based on your research what do you think would be the best option for Katrina’s Candies?

Herb: I would have to say that product extension and market extension sound like the most viable merger types to accomplish the Board’s discussion to expand Katrina’s globally.

Ken: Why did you exclude the possibility of a “horizontal merger”?

Herb: During the team’s investigation of Katrina’s market structure, we learned from concentration ratio statistics that Katrina’s Candies is in an oligopolistic market. A few firms already dominate the market. However, although there are a few very large firms in the chocolates’ industry, there are about two hundred firms of other sizes. Merging horizontally in this type of industry would monopolize the industry and I don’t think the Federal government would approve.

Ken: The Federal government has to approve mergers?

Herb: Yes, companies proposing to merge must make the merger plan available for government review and approval.

Ken: Interesting! Okay, who’s next?

Gigi: I’m next. I wanted to know whether merging firms is a common practice. I also learned about the management impact of a merger. My contribution is in the form of a short video. This video illustrates the importance of thoughtful planning to avoid the negative side effects of mergers. Coincidentally, one of the featured firms is a chocolate manufacturer.
Slide 9 Scene 9
Interaction Slide
Ipad will be showcasing the videos:
• How to take charge and plan for the future of your business.
o http://www.youtube.com/watch?v=7C_z8UuCJ-Y

Slide 10 Scene 10
Gigi and the rest of the team are in the conference room. Gigi continues to talk about her findings.
Gigi: As I listened to opinions about how firms are using mergers to grow their companies, I understood why Ken is interested in merging Katrina’s with another firm.

Renee: I agree! As I was listening to the video, I also began thinking a merger might be a good strategy. I’ll explain further after you finish Gigi.

Maria: Actually I was more focused on the message in the “Nutty Chocolate” video, the message that firms must plan a merger or face disaster during the initial post-merger phase. It was sort of scary to me but when I saw how different outcomes can occur when a plan guides the merger my fears subsided.

Ken: This is the type of dialogue I’m considering! But before we dissect the issue without hearing from everyone, let’s hear from Renee and Maria.
Slide 11 Scene 11
Maria and the rest of the team are in the conference room. Maria begins to talk about her findings. Maria: Some of what I was going to share has been covered by others. So I’ll confine myself to explaining the profit enhancing potential and tax advantages of merging with another company. Based upon my research, I learned Katrina’s Candies could reduce average costs of production by merging with the right type of firm. For example, if it were to merge with a firm that supplies inputs we use to manufacture chocolates, input costs would decline leading to a reduction in the average total costs. Also, if the firm we merge with is unprofitable, yet has market shares, it could realize savings through tax write-offs. Either of these cost-reducing methods would ultimately increase profits.

Ken: Great research Maria! Renee, your turn now.

Renee: The information I learned also focuses on cost savings. Merging offers the possibility of economies-of-scale from increasing in size and offers the benefit of reducing the risk that’s associated with a capital expansion. Since performance data already exists for both firms, there are essentially no secrets and Katrina’s Candies would not be exposed to as much risk associated with a capital expansion; assuming, of course, we identify the right type of firm.

Gigi: Ken, there are also some unfavorable aspects from merging firms. The merger plan video illustrated a couple. One issue is the duplication problem that results when management teams from different firms are appended to each other, which can make duplication costly. There is also the possibility of misallocations of resources.

Renee: An additional problem occurs when it’s time to decide what name to use for the merged firms. Which firm’s name is retained for the merged firm; or, is neither name retained?

Herb: Then there is the matter of organizational form the new firm would take. A decision would have to be made as to who would own and manage the merged firm. This could deal with whether the merged firm would be jointly or separately managed. Assets are also impacted. Keep in mind that the “principal-agency problem” becomes a major concern under the merger scenario especially if merging companies opt to maintain separate managements.

Maria: The other very important issue is that in addition to government approval, mergers require stockholder approval. I checked Katrina’s Candies approval quotas and two-thirds of the stockholders must approve a merger.

Herb: Two-thirds, that’s a lot!

Ken: Yes, it is. However, there’s no way around that stipulation. If a merger is the preferred strategy for further expansion of Katrina’s global position, we’ll have to take our chances with stockholders.

Maria: If necessary, we could put a campaign together to solicit stockholder votes. We used campaigns in the past when we needed the stockholders to approve other types of changes.

Herb: Is there any information about the impact mergers have on stockholders?

Ken: Hold-on, we don’t want to get ahead of ourselves. I know I said we would meet until we reach consensus; however, the information I’ve heard so far adds a complexity to the situation I didn’t anticipate.
Slide 12 Scene 12
Herb and the rest of the team are in the conference room. Herb then explains another important merger type.
Herb: I don’t want to further complicate the matter, however, instead of combining Katrina’s Candies with another firm, why not implement a “contract merger” This is a form of merger I totally forgot to mention. Using this kind of merger would negate the need for stockholder approval as it’s called a contractual agreement.

Ken: What type of merger is this?

Herb: There are several types of “contractual mergers” but each shares the common feature that firms merge without actually combining companies. Here’s a short list of types of contractual mergers that could be utilized by Katrina’s. Katrina’s could merge via contract. For example, Katrina’s Candies could enter into a vertical contractual agreement with either a supplier or distributor. A contract would achieve the desired goal of expanding it without the problems associated with a merger such as duplication of services, stockholder approval, government approval, and so on. Also, the capital investment required when firms merge in the traditional way is also significantly reduced when contractual merger is used.

Ken: Thank you for sharing this with us Herb. This could be very useful!

Herb: Do you have a particular company in mind, Ken? I think the teams’ opinion about both merger types is going to depend upon the firm you have in mind.

Ken: I have a few companies in mind currently but nothing is set in stone yet.
I feel that for now, we have sufficient information about mergers that we can turn this matter over to Herb to include in his presentation.

Herb: You are right Ken, we went over a lot today and this sounds like a good place to stop. Team; please send me whatever comments you may have along with your recommendations about merging. Before we all go I think it would be best if we did a review since we covered so many new topics today. Therefore, I would like for you to participate in a review activity I put together based on the key items we discussed.

Slide 14 Scene 14
Check Your Understanding
Simjuck and DoDoBird Inc. are proposing to merge. Simjuck produces and sells dehydrated seafood; its market share is 38 percent. DoDoBird Inc. owns a chain of restaurants located across the country and has a market share of 22 percent. If the federal government approves Simjuck’s and DoDoBird’s merger, the horizontally merged firm will control 60 percent of the industry. Is this statement True or False?
False is the Correct answer.
Explanation: The statement is false. Simjuck’s and DoDoBird’s merger would not be a horizontal merger. Horizontal mergers occur when both firms sell or produce or manufacture the same product.
True is the Incorrect answer. The statement is false. Simjuck’s and DoDoBird’s merger would not be a horizontal merger. Horizontal mergers occur when both firms sell or produce or manufacture the same product.

Slide 15 Scene 15
Summary
Concluding scene taking place in conference room Herb: I hope this review activity was helpful to everyone!

Ken: Yes, it was helpful.

Gigi: I agree!

Maria: Thank you for sharing this with us, Herb!

Renee: Yes, Thank you, Herb.

Herb: You are all welcome! Let’s now start our final review about what we all discussed today. Who wants to go first?

Ken: I will go first! We learned that mergers can be used to expand firms. We also took note that U.S. firms planning to merge must obtain approval from the federal government.

Maria: We also learned that stockholders must also approve merger plans.

Gigi: During our discussion today, Herb showed us that recent trends in the U.S. and around the world show an increase in merger activity.

Renee: We later talked about the outcomes of merging is dependent upon the type of merger the firm makes. We also made note of some recommendations advisors made pertaining to the merging only if the merger is revenue enhancing.

Herb: Lastly, I talked about contractual mergers and mentioned that they can be used in place of capital investment mergers.

Ken: Fantastic review everyone! I’m excited to continue our discussion about the direction Katrina’s Candies will be taking to expand globally! Until we meet again, don’t forget to complete your weekly threaded discussions based on the key concepts we covered this week. Have a great day everyone!

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