BOUNDARIES OF FIRM and M&A: HORIZONTAL EKINDUS S

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1 BOUNDARIES OF FIRM and M&A: HORIZONTAL EKINDUS S1 2021

2 INTRODUCTION: A FIRM A firm is an organization that transform an input (resources) into a valued output (good/services) that can be sold For that, it has to make decisions such as what to produce, how much to produce, what input do we use, where and how to get input, what price to charge, where and how to sell product, etc. All of these decisions will affect what the particular firm actually does (activity) and/or its relative size (≈ boundary of a firm) Boundary of a firm is one of important factors when making corporate strategy/action

3 BOUNDARIES OF FIRM To be able to identify boundaries a firm, one needs information on environment where the firm operates (≈ market). Hence, determining the relevant market is the most important thing to do !! There are two types of firm’s boundaries: (i) horizontal and (ii) vertical

4 DETERMINING RELEVANT MARKET The process is called market delineating process Important factors need to be considered : * the product market * the geographic market The main idea of the process is to identify the available relevant substitutes for the particular product and/or geographic market. It is an iterative process. Additional factors to be considered may include: time, production line. S1S1 A BC D E F G J H I S2S2 S

5 TAXONOMY BOUNDARIES OF FIRM Boundaries of Firm Horizontal (Size-variety) Quantity/Size (Economies of Scale) Variety (Economies of Scope) Vertical (Activity)

6 MERGER & ACQUISITION Mergers & Acquisitions (M&A) is a firm’s strategy/action that changes/transforms its boundary in order to achieve long term goal. Such a transformation is carried out by taking control of another (target) firms. Taking control of (i) ownership; or (ii) asset of the target firm Key elements of M&A from an economic view is the presence of transfer of ownership and/or control from target firm to the acquirer

7 M&A is also considered as a form of business transaction between two or more firms that leads to a join up or amalgamation of the firms Such transaction can be carried out in different ways through: a) stock swap; b) cash payment; c) buy shares; d) buy assets Subject to tax Types of M&A: (i) HORIZONTAL (same relevant market); (ii) VERTICAL (different market but related/subsequent); (iii) CONGLOMERATE (different market and unrelated) MERGER & ACQUISITION

8 M&A: LEGAL PERSPECTIVE M&A is often used interchangeably. But in fact, there is a slight difference b/w the two from legal perspective. Acquisition: one firm takes over another and established itself as the new owner. The target firm may completely or partially cease to exist, while the acquirer now “control” the business Originally a merger: two or more firms, agree to go forward (combine and blend) as a new single larger firm. Consequently, the old firms are no longer exist

9 M&A: LEGAL PERSPECTIVES Company A Company B Company C Company X Company Y Company X 9 Merger with Consolidation Acquisition

10 HORIZONTAL & VERTICAL M&A

11 HOW DO M&A WORKS Parties involved  Share holders  Management  Employee External Parties Government Consumer Rival firms Community Other related firms The acquirer and the target firms 1 Define M&A strategy 2 Find target firm 3 Sign MOU 4567 Due Diligence Submit bid, SPA Negotiate bid, SPA Close the deal

12 REASONS TO RERGULATE M&A Depends on whose perspective : Government may not like the merger of a foreign firm with the native firm, or a merger may not fit with the industrial policy of the government, or if a merger leads to unemployment the government may not approve that. Firm may object to the merger because it can become a target of a hostile bid, or a merger can give an edge to the other firms. Shareholders may think that the merger may have an effect on the value of their shares.  Competition agency focuses on maintaining the competition with the aim of maximizing consumer welfare.

13 REGULATION M&A Regulation of M&A Antitrust Law Company Law Securities Law (go public) 13

14 HORIZONTAL M&A: SAME RELEVANT MARKET Horizontal boundaries identifies the quantities (SCALE) and varieties (SCOPE) of goods/services that firm produces  relative size of a firm It varies across industries. One industry (class of market) may have many or few sub-markets Sub-market Carbonated drink Coca cola, Pepsi, Fanta, Sprite, etc Sub-market Spring Water Aqua, Evian, Vit, Ades, etc Sub-market Bottled tea Teh Sosro, Teh Pucuk, S-Tee, Frestea, etc SOFT DRINK MARKET Sub-market energy drink Gatorade, Powerade, Myzone, etc Sub market MEN/WOMEN SHOES Sub-Market SPORT/NON-SPORT SHOES SHOE MARKET

15 TYPES OF HORIZONTAL M&A HORIZONTAL M&A MARKET EXTENSION (same industry but different location) PRODUCT EXTENSION (same industry but different variety)

16 HORIZONTAL M&A: MARKET EXTENSION 16 A BC D E F G J H I S2S2 AREA/COUNTRY 1 AREA/COUNTRY 2 SEMEN GRESIK Resmi Akuisisi 70% Saham Thang Long Cement Vietnam (Bisnis.com18 Desember 2012 ). Indofood Perbesar Kepemilikan di Produsen Mi Asal China (Kompas.com - 04/09/2013) S1S1 A BC D E F

17 HORIZONTAL M&A: PRODUCT EXTENSION 17 Sub-market Carbonated drink Coca cola, Pepsi, Fanta, Sprite, etc Sub-market Spring Water Aqua, Evian, Vit, Ades, etc Sub-market Bottled tea Teh Sosro, S-Tee Frestea, Teh Gelas Teh Pucuk SOFT DRINK MARKET Sub-market energy drink Gatorade, Powerade, Myzone, etc

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19 MOTIVES FOR HORIZONTAL M&A - Create synergies: better use of resources - Achieve economic of scale and scope : reduce cost, blend expertise - Increase revenue/market share: holding dominant position - Increase market power: to monopolize the market - Executive gains: a bigger firm is easier to raise more capital - etc

20 COMPETITIVE IMPACT: HORIZONTAL M&A Often raises concern of antitrust agencies Not only substantially reduces competition between the merging firms, but it also directly make the market structure more concentrated (reduce the number of operating firms in the market) HHI (Σ s i 2 ) and CR n (Σ s i ) rise up It may also open up an opportunity for conducting anti-competitive acts by the firm in order to attain or maintain its market power. 20 Where n is the number of sellers. A merger reduces n, hence increases the price-cost margin and reduces TS, other things being equal.

21 HORIZONTAL M&A: COMPETITIVE HARM Unilateral (non-coordinated) effects  arise when the competition between the products of the merging firms is eliminated. It allows the entity to unilaterally exercise power over the market like a dominant entity. It can raise the price of one or both of merging parties’ products. Coordinated effects  arise when under certain market conditions whether the merger will make it more likely for a merging parties and their rivals successfully able to behave collectively in an anti- competitive way (e.g. raise prices, monitor/detect/punish deviations)

22 WELFARE IMPACT OF HORZONTAL M&A Classic Trade off b/w Benefit v. Cost Benefit generally involves cost efficiency (technical/managerial) as a result of EOSS  lower P & higher Q. Cost involves potential anti- competitive effect; abuse of market power  charging higher P & produce lower Q A two sided coin 22 q2q1 p1 c1 c2 p2 W income transfer A2 cost saving A1 DWL Δc Δp Δq P 0 Q A2 = Δc.0q2 DWL (A1) = ½ Δp Δq Pre-merger condition: p1 = c1 (no market power) Post-merger condition: p2 > p1; create DWL (A1) However, there is a gain to society due to cost saving area (A2) Relationship b/w A1, A2 and W is the main concern of antitrust agency, and it depends on: size of p2; size Δc; price elasticity of Dd (η) A2 > A1 welfare enhancing A2 = A1 welfare neutral A2 < A1 welfare reducing

23 PERCENTAGE COST REDUCTION ( ΔC/C 1 ) SUFFICIENT TO OFFSET PERCENTAGE PRICE INCREASE FOR SELECTED VALUES OF ELASTICITY OF DEMAND ΔP/P 1 (%) η 321 ½ 50.440.270.130.06 102.001.210.550.26 2010.385.762.400.95 Source: Viscusi, Vernon, and Harrington, Table 7.1, p. 204

24 SAFE HARBOR FOR MERGERS Under 1992 U.S Merger Guidelines SafeUnsafe Safe Unsafe Safe 1800 1000 50 100 Increase in HHI Post-merger HHI

25 Example: HHI Consider an industry that has six companies. Their respective market shares are as follows: What is the likely government action, if any, if Companies E and F combined? 25 CompanyMarket Share A25% B15% C D E F 100%

26 Example: HHI Company Market Share HHI BeforeCompany Market ShareHHI After A25%625A25%625 B15%225B15%225 C15%225C15%225 D15%225D15%225 E15%225E+F30%900 F15%225 Total100%1750Total100%2200 26 The industry would be considered moderately concentrated before and after the combination of E and F, and The change in the HHI is 450, which may result in a government challenge.

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