Question

In this scenario, imagine that you are the financial manager of a major corporation. The CEO has asked you to explain the reasons to consider different types of business combinations, and ways to structure them (joint ventures, mergers, strategic alliances, and more). You, as the financial manager, should compose an email with this explanation. Assume the CEO is not a finance expert.

In your email to the CEO, address the following points:

1. Explain the reasons to consider different types of business combinations.

2. Describe different ways to structure business combinations.

Answer 1

1. Reasons to consider different types of business combinations :

When two or more business organizations combine together with some common purpose then it is termed as the business combination. The business combination can be divided into three types. These types of business combination discussed below:

Horizontal Combination

Combinations are said to be horizontal when a company producing or distributing goods of the same type or in the same stages of production, combines and comes together under one management and control. For example-Bangladesh Drug Association, Bangladesh Sugar Industries. It is also apprehended as parallel or trade unit combination. It is Modified by units engaged in manufacturing similar stocks or rendering the same co-operation. It involves the returning together of competing firms under single purchase and management. For instance, if two or more sugar mills are connected under the same management, it will be a crisis of horizontal combination. Tata Iron and Steel Ltd plus associated cement business are the illustrations of the horizontal combination.

Characteristics of horizontal combination:

• Engaged in the same type/line of business: Same line or types of business are the prerequisites for horizontal combination and this is the main characteristic of the horizontal combination.
• Single ownership and control: Two organization get together for the same purpose but their ownership should be same.
• Same types of goods produced: Mostly horizontal combination happen between two or more business organization when their goods or product are same.
• The existence of perfect competition: Both or all business organization should require perfect competition for the horizontal combination

Vertical combination

Under vertical combination, the combining units represent various successive stages of productive activities either of the same industry or of various industries connected in a sequence. It is also known as string or industry or process integration. It arises as a result of the combination of those companies which are interested in the different stage of production of a product. In other words, it implies sequence under single control of enterprises in varying stages of manufacturing the product. The aim of vertical integration is to attain self-sufficiency as regards raw elements and distribution of finished commodities. Two or more business units occupied in successive stages of the product, or creating articles leading to the same final product, may combine and manage all degrees of crop and the distribution of the last stock. For example, in cotton textile manufacturing, there may be a combination of units engaged in progressive stages of cloth production.

Characteristics of vertical combination:

• Different ownership and control
• Different stages of production

Objectives of vertical combination

• Elimination of wasteful expenses
• Elimination of unnecessary expenses
• Securing economic advantages
• Quality control

Lateral Combination

t refers to the alliance of business units producing and Selling different but allied products. The parallel combination may be either convergent or diverging. Concurrent parallel combination arises when firms producing several products but supplying to a regular user join with him. For example, brick manufacturer, stone supplier, concrete supplier, and a wood supplier may integrate with a construction organization; Divergent parallel combination represents the combination of one supplier of a standard raw material with different users. The example of different lateral integration is presented by a flour mill supplying flour to some units like the bakery, confectionary, and hotel.

2. Ways to Structure Business Combinations :

Successful business combinations — those that turn out to be a profitable use of resources — all follow the three laws. These laws are not formulated as commandments or orders, but are necessary conditions for success. All business combinations must have the potential to create joint value, must be governed to realize this value, and must share value in a way that provides a reward to each party’s investment. Each law points to a set of practical implications:

• First law: The combination must have the potential to create more value than the parties can alone. The first law asks these practical questions: How much more value can we create in the market together? What specific resources must we combine to create this value?
• Second law: The combination must be designed and managed to realize the joint value. Which partners and structures fit this goal best? How do we manage the risk and uncertainty inherent in such combinations?
• Third law: The value earned by the parties must motivate them to contribute to the combination. How do we divide the joint value created? How will value be shared over time?

Taken together, the laws provide a powerful, systematic approach for creating and capturing value from your partnerships—from when to form a combination, to how to manage collaboration, to how to ensure that you get a return on your efforts.

These three laws determine the success of any business combination, and at first glance, they’re easy to grasp. But each is deeper than it looks. And living by them is tricky in practice. Often, one or the other gets short shrift in the rush to strike a deal or gets lost in the glare of a promising future. Another practical problem is that because each law revolves around a different school of thought in strategy and management science, experts in one area can easily miss cues in another and, in doing so, inadvertently plant the seeds for a costly retreat later on. To avoid these pitfalls, we will need to dig deeper into each one of the laws:.

First Law: Identify Potential Joint Value

In casual conversation, the idea of creating value in combinations is often expressed as 1 + 1 = 3, or some such mathematical metaphor. As explained, the first law for a business combination is that the remix must have the potential to create more value than the resources can generate when governed separately, that is, without being combined. In common business language, the combination has to produce synergy. I hesitate to use that term because of its reputation as a business buzzword. But the bad rep comes from ignoring the complex processes involved in creating value in combinations. To actually produce synergy and achieve real results, you need to pay attention to all three laws.

Second Law: Govern the Collaboration

The second law of business combinations is that they must be implemented in a way that creates joint value in reality, not just on paper. In other words, the combination has to act as an integrated operation in those areas that count for value creation. We might summarize this law as 1 + 1 = 1, referring now to unity in the management of the combination, not to its economic rationale.

Third Law: Share the Value Created

Even when joint value is created by a well-governed combination, your company might not receive enough of the value. That’s why the last law is certainly not the least: ultimately, the joint gains need to be divided in a way that leaves each party better off than it would have been without the combination. The share of profits is the reward, or incentive, that encourages each party to contribute its resources to the combination. To continue the metaphor, the 3 in the 1 + 1 = 3 of the first law needs to be divvied up. The shares are not always predetermined and don’t need to be equal. So, perhaps the summary formula will look like 1 + 1 = 1.4 + 1.6. The split can also be 50-50 or 80-20 or anything else. What matters is that each party earns a fraction high enough to convince it to redirect its assets and efforts from another use into the combination.