What is Business Combination?

Examples

#1 – Horizontal Combination

This type of consolidation of two or more organizations operating in the same line of business. This combination results in a reduction of competition and larger market capitalizationMarket CapitalizationMarket capitalization is the market value of a company’s outstanding shares. It is computed as the product of the total number of outstanding shares and the price of each share.read more.

Example

A combination of two major sugar manufacturers, ‘Sugar bell’ and ‘Crystal Sweeteners’, operating in the same line of business is an apt example of a horizontal business combination. This would result in the termination of the competition.

#2 – Vertical Combination

The vertical combination is a combination of different stages of the same business. For example, many businesses operate independent businesses at different stages. This is also known as sequence combination or process combination. It combines different departments under one single control point. The key objective is to reduce the per-unit cost of production.

‘Mountain Mist,’ a packaged water manufacturer, combines with a PET bottle manufacturer ‘Beige Plasto.’ This type of combination will bring two different processes under single management. In addition, the inclusion of the bottle manufacturing unit under the same management will reduce per-unit cost.

#3 – Lateral Combination

This type of business combination is the combination of two businesses that deal in a different line of business; however, they are connected in some way or another.

A convergent combination is the combination of different business units, say suppliers of raw materialsRaw MaterialsRaw materials inventory is the cost of products in the inventory of the company which has not been used for finished products and work in progress inventory. Raw material inventory is part of inventory cost which is reported under current assets on the balance sheet.read more to a major firm. In this type of combination, the larger firm benefits from supplying raw materials and its inventory under its control.

Supplier A deals in printer ink, papers, and folders, and Supplier B deals in the same business. ‘Pressfit’ is a leading printing press. Supplier A and B with Press Fit will be a concurrent combination.

A divergent combination is the combination of major firms that operate in related businesses that use the major firm’s products as raw material.

An oil refinery organization gives its crude oil to its dependent organizations as raw materials. The downstream industries use this for creating petroleum and machinery oils. The combination of such a business is called divergent lateral combination.

Diagonal combination refers to a combination of the manufacturing companies with a service-related business. This helps businesses provide service for the products that have been sold and creates a sense of customer satisfaction and trust since the customer can expect after-sales service at the hands of the organization itself.

Service centers for various mobile phone manufacturers are not owned by the manufacturer but authorized by them. In this way, the service center can cater to the customer’s needs by delivering original spare parts and providing a service that is authentic and reliable.

Mixed combinations are also termed Circular combinations. These unrelated businesses combine to form a new business called a mixed combination. The new business form will have insights from the management of both the organizations, which will help create an organizational and functional structure that creates the most efficient way to operate the business.

An insurance company combined with a shipping and cargo company to form a new business is an example of a mixed combination.

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Advantages

  • Managing the business becomes efficient since decisions can be made based on a holistic view of the key areas of business.The major advantage of a business combination is the economies of scaleThe Economies Of ScaleEconomies of scale are the cost advantage a business achieves due to large-scale production and higher efficiency. read more, which refers to reducing the per-unit cost of production.Reduced competition, in other words, refers to increased market capitalization and a relative spike in the profits gained.The businesses’ customers would benefit from the combination since the new organization will engage in activities to enhance the current procedures to deliver a better product to the customers.

Disadvantages

  • Loss of employment – Since processes will be combined, the workforce required for certain tasks will be reduced.It can result in a disparity of the economy since the economic power would be transferred to a few people managing the industry. Thereby creating differences in the income distribution in the economy.At the initial phase, communicating effectively and bringing each department or business unit on the same page is a mammoth task since there can be cultural differences among the employees of the organizations. This can result in inefficient coordination and require rework for a simple task.

Important Points

The factors below are of utmost importance in the business combination, which involves one organization taking control of the other business.

  • Target Business Viability – The target business should have assets, processes, or other inputs that can be viable for the acquiring organization to benefit from the transaction.Consideration – The transaction is completed only when the acquiring organization transfers a pre-agreed amount as cash, equities, or liabilities receivables to the target business, which is termed as Consideration.Control of the Business – The acquiring organization needs to own 50% stakes of the target organization to have the organization’s controlling rights.

This has been a guide to the business combination and its definition. Here we discuss its types with examples, advantages, and disadvantages. You can learn more about Corporate Finance from the following articles –

  • Vertical IntegrationHorizontal IntegrationHorizontal MergerSubsidiary Company