Evaluate the potential economic consequences for economic agents of an horizontal merger

 

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Horizontal mergers occur when businesses at the same stage of the supply chain join, either because of an agreed merger or a takeover. In doing so, they could be lowering long-run average costs, and thus gain economies of scale. If the new combined business moves nearer to, or is afterwards at, minimum efficient scale, this could also improve the efficiency of the economy. Businesses could also gain several advantages, not least of which would be a lower overall debt, and a greater ability to spread risk across the firm’s operations.

Ideally, an horizontal merger will result in a lowering of duplication of administration in the industry, increased productivity because of the ability to specialise and to increase the division of labour, and the creation of more secure specialised supply chains and business divisions than existed previously. Firms could gain physical economies in terms of larger offices and warehouses for the combined firm than for any single one, and internal economies such as improvements in personnel, distribution, finance, technology, and specialised management. Workers would tend to apply to companies, rather than companies search for workers, in large organisations.

External economies in the form of lower advertising and marketing (fixed) costs compared to the size of the firm would also arise. In addition, the commercial media (properly managed) tend to provide free publicity and marketing opportunities for large firms. In some cases, local and national government might specifically provide for subsidies for the firm or its workers, such as transport to and from offices, cheap land, or tax breaks, which would further lower costs.

Technology often benefits larger organisations more than smaller ones. Information management systems, for instance, can be tailored and accompanied with close support for bigger organisations, whereas smaller ones might have to solve problems themselves or wait in a long queue. IT departments can own servers, rather than rent space on servers belonging to others at a premium.

Airlines and trains could run more frequent or larger trains, physically and internally lowering average costs, though this approach would depend on steady markets and customers. Airbus, for instance, invested heavily in the 1990s and 2000s on large craft which could lower the average cost of carrying one of hundreds of customers. This contrasted with Boeing, which concentrated on short-haul smaller craft which could make more frequent journeys, or which cost less to withdraw from service and park, in terms of shut down, storage, and re-engagement costs. Both approaches benefitted from being provided by very large firms, however, rather than several smaller ones, suggesting that horizontal mergers which increase size also increase business choices where barriers to entry of a market are high.

By contrast, some horizontal mergers are unequal, and create barriers to entry. For example, the ‘big tech’ sector composed of Meta, Alphabet, and Tesla (which at the time of writing is attempting to buy a famous social media app to link to its starlink service) has famously grown in part by an aggressive process of horizontal takeovers which assimilate companies with innovative ideas. This was also true of the energy industry before it, though in the latter case, the oil industry tended to buy ideas to shelve them rather than to use them as their own.

Horizontal mergers can benefit the financial position of companies. This is because the combined debt of the two companies might be less in proportion to the new size, revenues and profits of the bigger merged company because of the lower average costs that come with economies of scale. Also, shareholders prefer the security and stability of bigger companies to smaller ones, banks offer lower interest rates on new loans if a company has greater assets than small ones and retained profit levels can simply be greater in absolute terms. 

As Meta's ongoing virtual-world fiasco shows, however, big companies can also make big mistakes. The purchase or agreed takeover of private limited companies by public ones can also reduce stakeholder welfare and bring with it negative externalities such as regional or sectoral unemployment.

Negative consequences of mergers can often be balanced by positive externalities, such as the effect of greater tax revenue for society, provided that horizontally merged firms are not allowed to avoid taxation. This is difficult in a globalised world, as larger firms can exploit different tax jurisdictions or simply capture regulators and legislators by lobbying.  Similarly, lower costs might mean higher profits rather than lower prices, especially if larger firms are allowed to engage in monopolistic practices such as price discrimination, or oligopolistic ones such as price-fixing.

Some mergers might also just make companies too big, and lead to diseconomies of scale after a period of monopoly abuse. Large firms might feel that they have no incentive to improve dynamic efficiency and could suffer from the y-inefficiency of not looking for new markets as well as the x-inefficiency of tolerating low productivity or bad management and poor working practices.  It is famously easier for richer companies, for instance, to solve employment or operational difficulties with money than it is for smaller ones which depend more on the credit of the owners than that of the company.

Finally, larger firms must balance their capacity for the development of robust human resources departments against their tendency to attract rent-seeking consultants, overblown IT infrastructure, and status-maximising agents who are not fundamentally interested in the intentions of the principal, leading to a classic principal-agent problem. This can result in lucrative employment for consultants who might periodically encourage costly reorganisation of the business, service, or product, only to offer the opposite advice at the end of each cycle of organisation in a parallel to public choice theory government failure. Large firms, in this and other regards, could also consequently find themselves facing more intense inspection by the media and regulators than they received as smaller enterprises.

The potential consequences for economic agents of horizontal mergers are therefore wide-ranging, and depend on the relative size, market structure, and objectives of the firms involved, but will usually result in economies of scale and lower long-run average costs—until they don’t.