A business combination is a form of creating a new business by two or more existing companies. It can be a merger, acquisition, or takeover of one business by another.
Let us discuss what is a business combination and its different types.
What is a Business Combination?
A business combination is a transaction where one business acquires one or more businesses.
A business combination is formed only when the acquirer takes control over another business entity. If there is no transfer of controlling interests, it cannot be recognized as a business combination.
The accounting treatment of a business combination also depends on the transfer of control and the application of relevant accounting standards like IFRS 3.
When two or more businesses come together for a specific project or without the transfer of control, it can be termed a joint venture or partnership.
Also, a business may acquire only assets and liabilities of another business entity. A business combination would only be accounted for if a formally recognized business is acquired and not only its assets or liabilities.
What are the Types of Business Combinations?
Business combinations can be of different types depending on the objectives of the entities joining hands. The acquirer decides the type and structure of the new business combination.
Here are the top six types of business combinations that are used widely.
Horizontal Business Combination
This type of business combination occurs when two or more businesses in the same line of production join hands.
It means a horizontal business combination occurs when two direct competitors form a new business.
Large businesses acquire emerging and growing business competitors to retain their market shares. However, certain regulatory requirements may restrict a hostile takeover.
Most jurisdictions do not allow such business combinations where it may result in a market monopoly. However, if it does not significantly affect the market competition, it may be allowed by the regulators.
Vertical Business Combination
A vertical business combination happens two companies that produce different products but are in the same market line join hands.
A vertical business combination is common for businesses working in the same supply chain line. Usually, the larger producer of the main product combines with the supplier to improve the supply chain.
Vertical combinations also face the same regulatory restrictions. The regulators allow such combinations only if there is no breach of the “perfect market competition” rule.
An example of a vertical combination can be a cable company acquiring a media house. Although both of these companies offer different products/services, their target audience and the market line are the same.
Market-Extension Combinations
This type of business combination is formed when two businesses selling the same product in a different market merge.
Such combinations happen when a business looks for market expansion. For example, if a local manufacturer of smartphones wants to enter a new international market by acquiring another local business there.
Market extension business combinations are related to the geographical expansion goals of the acquirer. The acquiree is often a small but growing company in the preferred destination.
As the name suggests, the goal of a market extension combination is to capture a larger market share and grow the business base.
Product-extension Combinations
A product-extension business combination happens when two businesses sell the same products/services from a new combination.
The product expansion is different from the horizontal combinations as the two businesses here are not direct competitors of each other.
Another key distinction of the product extension combinations is that both companies coming together would be selling related but different products.
These businesses aim to join hands to extend their product ranges. It means they appeal to a new customer base to grow their businesses.
The important factor for product-extension combinations is to target a similar customer base with similar products or common interests.
An advantage of this type of business combination is that businesses do not face regulatory restrictions as compared to horizontal or other types of combinations.
Conglomerate Business Combinations
A conglomerate business combination or merger happens when two businesses selling unrelated products form a new business.
A pure or common conglomerate happens when two businesses selling unrelated products in a different market merge. Another form of a conglomerate is when two businesses come together when looking for product extension or market growth.
It is also used as a market penetration strategy when a new entrant acquires an established business in an existing market.
This is a risky form of business combination. Conglomerate business combinations face most hurdles when operations of two unrelated businesses come together.
Congeneric Business Combination
A congeneric business combination is when two businesses with different products but the same customer base come together.
This type of business combination is further classified into horizontal, vertical, or conglomerate combinations.
Although two businesses produce different products/services, they target the same audience. It means their target customer base shares common interests in their unrelated products.
The formation of Citigroup is a famous example of a congeneric business combination. It was a merger of two companies Citicorp offering traditional banking services and the Travelers Group offering insurance services.
Advantages of Business Combinations
Businesses merge or acquire for several advantages. Each type of business combination offers a discrete advantage to the businesses coming together.
A horizontal business offers combination synergies, market expansion, and economies of scale to name a few advantages for the acquirer.
A vertical combination offers control over the supply chain as the biggest advantage. That in turn, reduces the costs of inventory and increases profit margins for the acquirer.
A conglomerate combination comes with the biggest advantage of market expansion. It allows businesses to expand into new market locations.
Similarly, a congeneric business combination helps two businesses gain the advantage of the same customer base. They merge their production lines to take advantage of the same market share.
Generally, businesses acquisition and mergers offer the following advantages for all types:
Achieving synergic business combination benefits.
Achieving economies of scale to reduce the per-unit cost of production.
Business growth in quick time.
Product/market expansion
Improved quality of product/services for the customers.
Some businesses acquire other companies to gain access to a specific technology, trademark, or patent rights.
Disadvantages of Business Combinations
Although business combinations offer several advantages to both sides, there are limitations and challenges to achieving these benefits.
The biggest challenge is that business combinations of large companies and direct competitors may create a market monopoly. Therefore, if two giants in the same market combine, they can be challenged by the regulators.
Achieving business mergers or acquisitions synergies is often challenging. It is particularly difficult when two companies with different product ranges join hands. Also, it is challenging when the management of two unrelated businesses from different locations joins hands.
If a business combination fails for any reason, it costs significant losses to both companies and their employees.
Almost all types of business combinations result in employee layoffs. Therefore, a business combination will be resisted by the employees of both companies more often than not.
In short, although business combinations look attractive financially, they possess serious challenges. All business entities joining hands should consider these challenges and plan accordingly to maximize their chances of success.
