Ref # 008 - ECO 550 Managerial Economics and Globalization - Week 8
Discussion
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Question :
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"Organizational Form" Please respond to the following:
* From the scenario, examine the major implications for firms entering into a merger. Develop key
guidelines to follow when creating the terms of the merger in order to benefit all parties concerned.
Examine two (2) organizational forms of business (e.g., functional, product, etc.). Predict the possible
implications of the principal agent relationship for each of these organizational forms of business.
Determine which of the organization forms would have more of an economic impact on the operations of
the firm and its ability to maximize profits. Provide a rationale for your response.
This corresponds to the following scenario:
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-freechocolates; 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-andacquisitions-biggestdeals2013/#.UtLKqNJDuAg
 Cineworld merger widens vision
as Europe’s second biggest
cinema chain.
o http://www.theguardian.
com/business/2014/jan/1
0/cineworld-mergereurope-second-biggestcinema-chain
 Cross-border mergers and
acquisitions deals soared in
2013.
o http://www.haaretz.com/
business/.premium1.567841
 Institute of Mergers,
Acquisitions and Alliances
(IMAA)
o
Slide 7
http://imaainstitute.org/statisticsmergersacquisitions.html
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
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.
Show chart showing China’s mergers
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.
Show prepared chart of Types of
Mergers
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.
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.
Gigi then shares her findings about
mergers.
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 costreducing 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?
Slide 12
Scene 12
Herb and the rest of the team are in the
conference room. Herb then explains
another important merger type.
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.
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!