Operating synergy this theory assumes that economies

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OPERATING SYNERGY • This theory assumes that economies of scale do exist in the industry and that prior to the merger, the firms are operating at levels of activity that fall short of achieving the potentials for economies of scale. • It can be achieved in horizontal, vertical and even in conglomerate mergers. • Economies of scale arises because of indivisibilities, such as people, equipment, and overhead, which provides increasing returns if spread over a large no. of units of output. • Ex: one firm might be strong in cash but weak in marketing while another has strong marketing department without the R&D capability. Merging the two firms would result in operating synergy. • The R&D dept of chemical & pharmaceutical co’s often must have a large staff of highly competent scientists who, if given the opportunity, could develop & oversee a large no. of product areas. • One problem in merging is- how to combine and coordinate the good parts of the organization and eliminate what is not required? vertical integration is one area in which operating economies may be achieved. Costs of communication, & various forms of bargaining , & opportunistic behaviour can be avoided by vertical integration. • Combining firms at difft stages of an industry may achieve more efficient coordination of the difft levels. PURE DIVERSIFICATION Diversification of shareholders wealth through mergers along with the employees & managers of the company is termed as the pure diversification. Reasons: Demand for diversification by mgrs & other employees, Preservation of orgnal and reputational capital, Preservation of Financial and tax advantages. • Diversification of the firm provide managers and other employees with job security & opportunities for promotion and, other things being equal, results in lower labour costs. i.e., Firm-specific investment. • Firm-specific investment: knowledge acquired while working for the firm may be valuable to the firm but not to others .( employees are more productive in their current job than in other firms-specialized knowledge) Information on employees is accumulated within the firm over time. Information is used for efficient matching of employees and jobs or of employees themselves for a particular job-managerial & other teams are formed in the firm. • Diversification ensure smooth & efficient transition of the firm’s activities & the continuity of the teams and the orgn. 3. Firm have reputational capital which customers, suppliers, & employees utilize in establishing their r/s with the firm. • Reputation is acquired over time through firm-specific invts., in Advertising, Research & development Fixed assets, Personnel training, Orgnal devpt, & so on. • Diversification can help preserve the firm’s reputational capital which will cease to exist if the firm is liquidated. 4. With regard to financial synergy & tax effect, diversification can increase corporate debt capacity and decrease the present value of future tax liability. These effects are a result of the decrease in cash flow variability due to the merger.
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