What is Business Combination?
Business Combination is a type of transaction in which businesses aim to grow in size by means of one organization acquiring the other organization and therefore, takes control of the business activities and the employees of the other organization. In simple terms, it is a consolidation of two or more businesses as one to achieve a common goal by eliminating competition.
#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 capitalization.
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 terminate of the competition.
#2 – Vertical Combination
The vertical combination is a combination of different stages of the same business. Many businesses operate in 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. The inclusion of the bottle manufacturing unit under the same management will result in the reduction of 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 units of the business, 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. to a major firm. In this type of combination, the larger firm gets the benefit of having the supply of raw materials and its inventory under their control.
Supplier A deals in printer ink, papers and folders and Supplier B deals in the same business. ‘Pressfit’ is a leading printing press. The combination of Supplier A and B with Pressfit will be a convergent combination.
A divergent combination is the combination of major firms which operate in related business which uses the products of the major firm as a raw material.
An oil refinery organization gives its product which is 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 to 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 centres for various mobile phone manufacturers are not owned by the manufacturer but authorized by them. In this way, the service centre can cater to the needs of the customer by delivering original spare parts and providing a service that is authentic and reliable.
Mixed combinations are also termed Circular combinations. These are unrelated businesses that combine to form a new business is called a mixed combination. The new business formed will have insights from the management of both the organizations which will help in creating an organizational and functional structure that creates the most efficient way to operate the business.
An insurance company combines with a shipping and cargo company to form a new business is an example of a mixed combination.
- 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 scale, which refers to the reduction of per-unit cost of production.
- The reduced competition which, in other words, refers to increase market capitalization and a relative spike in the profits gained.
- The customers of the businesses 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.
- Loss of employment – Since processes will be combined, the workforce required for certain tasks would be reduced.
- It can result in a disparity of the economy since the economic power would be transferred to a few numbers of people that are 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 ask for rework being done for a simple task.
Below factors are of utmost importance in terms of the business combination, which involves one organization taking control of the other business.
- Target Business Viability – The target business should have assets, processes or any other inputs that can be viable for the acquiring organization to benefit out of 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 so that it has the controlling rights of the organization.
This has been a guide to What is a 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 –