Business Combination: Definition, Types and Forms of Business Combinations, Advantages, Disadvantages

Business Combination Definition, Types and Forms of Business CombinationsWhen a voluntary association of firms is formed to achieve common goals and to enjoy the monopoly advantages, that sort of initiative is called business combination.

The combination may be formed by a written or oral agreement among the firms.

Sometimes firms decide to merge themselves into one unit. The main object of the business combination is to achieve common economic welfare for its members.

But it is considered to be unlawful if any of its objectives is against the public interest. Business combinations may be permanent or temporary.

Types of Business Combinations

Combinations may take several forms, such as horizontal, vertical, lateral, and diagonal, circular, or maybe a mixture of two or more of these types.

Horizontal Combination

A horizontal combination comes into being when units carrying on the same trade or pursuing the same productive activity join together with a common end in view.

Example of horizontal combinations are;

  • Disney’s 2006 acquisition of Pixar.
  • Facebook’s 2012 acquisition of Instagram.

Horizontal Combination

The intensity of competition is naturally reduced when several units competing in the same line of business join together. The combining units can well take advantage of the various economics associated with large scale production by making common purchases, pooling resources for research, common advertising, etc.

Vertical Combinations

Vertical integration is the combination of firms in successive stages of the same industry. It implies the integration of various processes of an industry.

Vertical Combinations

Vertical combinations are brought into existence with the following objects in view:

  1. To eliminate the wasteful and unnecessary expenses involved in carrying on the connected processes separately.
  2. To eliminate middlemen functioning between various units
  3. To securer economies in marketing, advertising, and transport
  4. To maintain control over the quality of raw materials and finished products.

Lateral Combination

Lateral integration refers to the combination of those firms which manufacture different kinds of products though they are ‘allied in some way.’

It can be of two kinds;

  1. convergent lateral integration, and
  2. divergent lateral integration.

lateral combinations

The convergent lateral combination comes into existence when different forms join together to supply goods and services to help the functioning of major undertakings.

Example: For instance, a book publishing may join with other units producing paper, doing printing work, and providing bookbinding services.

Diagonal Combination

It is also called ‘Service’ integration Diagonal integration comes into existence when a unit providing auxiliary goods and services to industry is combined with a unit engaged in the mainline of production, within the organization.

Diagonal Combination

Example: For example, if an industrial enterprise combines with a transport company, a power station or a repairs and maintenance workshop, and makes these facilities available within the organization, it will be said to have effected diagonal integration.

Circular Combination

When firms belonging to different industries and producing altogether different products and combine under the banner of a central agency, it is called a mixed or circular combination.

This is affected to ensure smooth conduct of business operations by making timely availability of auxiliary services within the organization.

Circular Combination

Example, For example, Godrej is engaged in the manufacturing of cosmetics, electrical goods, office equipment locks, etc. The object is to secure the benefits of large-scale operations arising out of co-operation.

Forms of Business Combinations

Forms of Business Combinations

Combinations take different forms that have been developed over some time.

  1. Associations
    1. Trade associations.
    2. Chambers of commerce.
    3. Informal agreements.
  2. Federations
    1. Formal Agreement.
    2. Pools.
    3. Cartels.
  3. Consolidations
    1. Partial consolidations
      1. Trust.
      2. Holding companies.
      3. Community of Interest
    2. Complete consolidations
      1. Mergers.
      2. Acquisition.
      3. Amalgamations.

Associations

Business units combine to attain some purposes without surrendering their autonomy.

  1. Trade Associations

Under trade association, business units engaged in a particular trade generally come together and discuss matters for the promotion of their economic and business interest.

They are generally formed on ‘territory bases.

Such association is organized on a non-profit basis and is essentially educational. Sometimes the association may make representations to the government to safeguard the interests of a trade or an industry.

  1. Chamber of Commerce

Chamber of commerce is voluntary associations of persons connected with commerce, trade, and industry.

These are formed with the object of promoting and protecting the interests of business and business communities in a region, country, or even in the world as a whole.

Their functions include promoting, supporting, or opposing legislative or other measures affecting the trade interests of the members, the collection and dissemination of information concerning trade, commerce, etc. to members.

They also undertake the function of referring disputes arising out of trade activities to arbitrations for settlement, performing such other things as may be conducive to the expansion of trade.

  1. Informal Agreement

Informal agreements involve the exchange of promise among members regarding restriction of output, fixation of prices, etc. They are also referred to as Gentlemen’s agreements.

It is only the moral duty of business units to keeping the promise.

Federations

Federations form of combination aims at rendering benefit to member-units for certain specific purposes under an agreement. Of such federations, ‘ Pools’ and ‘Cartels’ are most notable.

  1. Pools

It means that the members of the pooling agreement joint together to regulate the demand or supply of a product without surrendering their separate entities.

The agreement may relate to the regulation of output, reallocation of output, redistribution of income, etc.

Haney defines and industrial pools as a form of a business organization established through a federation of business units whose members seek a degree of control over prices by combining some factors in the price making process in common aggregate and apportioning that aggregate among members.

  1. Cartels

A pool having a common sales agency is known as Cartel. It is, thus, an output and profit pool.

The object of a cartel is to eliminate competition by forming a federation of producers that pool the output, fixes the price, and sells the product. The profits reaped by cartels are distributed amongst the members – units on a pre-determined basis.

Consolidations

The last form of combination is consolidation. This form involves the highest degree of integration. The consolidation may be of two types:

Partial Consolidation

  1. Trusts

Trusts may be defined as a form of a business organization through temporary consolidation in which the shareholders of the constituent organizations under a trust agreement transfer a controlling amount of their stock to a board of trustees in exchange for a trusted certificate.

These trust certificates show their equitable interests in the income of the combinations.

Thus, trustees under the trust manage the affairs of the member concerns in the interests of the real owners, who are entitled to dividends based on trust certificates held by them.

  1. Holding Companies

A holding company is a form of business organization that is created to combine industrial units by owning a controlling amount of their share capital.

Controlled companies are referred to as subsidiary companies. The subsidiaries are independent and function in their name. But they are effectively managed by the holding company.

  1. Community of Interests

A Community of interest may be defined as a form of business organization, in which without any formal central administration, the business policy of several companies is controlled by a group of common stockholders or directors.

Thus, the administration of different companies is possible either through managerial integration, administrative integration, or financial integration.

Complete Consolidation

In complete consolidation, the combining units lose their entity.

It is defined as a form of business organization which is established by the outright purchase of the properties of the constituent organizations and the merging of such properties into single business units.

Complete consolidation may be of the following types:

  1. Merger

A merger takes place when; two or more organizations merge, and their operations are absorbed by a news organization.

  1. Acquisition

Acquisition refers to the process of acquiring a company at a price called the acquisition price or acquisition premium. The price is paid in terms of cash or acquiring the company’s shares or both.

To read more about mergers and acquisitions, click here.

  1. Amalgamation

Amalgamation is an arrangement where two or more companies consolidate their business to form a new firm or become a subsidiary of any one of the companies.

For practical purposes, the amalgamation and merger of the terms are used interchangeably.

Causes/Reasons for Business Combination

Although the business combination is primarily formed for achieving a common (single) goal, it may also be formed keeping in mind the following reasons:-

  1. Elimination of Competition

Due to hard competition among the firms’ rate of profit decreases. Some firms may suffer a loss also. So the industrialists feel pleasure in setting up a combination to avoid the competition.

  1. To Solve Capital Problem

Small units of production face the problem of capital shortage. They cannot expand their businesses. As a result, small units may form a combination to overcome this problem.

  1. To Achieve Economies

Some small units combine themselves to achieve the economies of large scale production advantage. It helps to purchase the raw materials at low prices and sell more product which would increase the profit

  1. Effective Management

Generally, small units are unable to hire the services of experts and experienced managers. So small industrial units combine themselves to hire the services of effective management

  1. Tariff Facilities

To compete with external firms, some industrial units combine themselves. The government also imposes heavy duties to protect domestic producers.

  1. Uniform Policy

All the units adopt uniform policy due to business combinations. It regularizes the business activities of all the units.

  1. Use of Technology

The business combination can use the latest technology and new methods of production because its sources are sufficient. In contrast, a single unit cannot do so.

  1. To Face Crises

It is very difficult for the small industrial units to face crises in the days of inflation and deflation. So the small units combine themselves to face these problems easily.

  1. Growth of Joint Stock Companies

The growth of Joint-stock companies has also made it possible for various industrial units to form combinations.

  1. Status in Market

A big firm enjoys a higher status and respect than the smaller one. So, small business units prefer to combine themselves for higher status.

  1. Demand and Supply Balance

A business combination is very useful in controlling the overproduction. It adjusts the supply according to the demand of the market. So overproduction cannot take place, and prices remain stable.

  1. Transport and Communication Development Activities

It has made economic activities fast. Now there is close contact with a businessman with the others. So it has also contributed to the growth of combination.

  1. Research Facilities

Small firms cannot set up the research department, while through business combination, these facilities can be enjoyed.

  1. Economic Instability

In the case of economic and political instability, there is a chance of loss in every moment. To reduce the risk, small industrial units combine themselves.

Advantages of Business Combination

The advantages of a combination are controversial because the creation of monopoly and elimination of competition both are considered the merits and demerits of the combination.

Anyway, the following are the significant merits of combination:

  1. Increase in Capital

The volume of capital may be increased by the formation of a combination. The members combine their resources to conduct large size business.

  1. Elimination of Competition

By the formation of combination, unnecessary competition is eliminated, and member firms earn monopoly profit.

  1. Saving in Expenses

Administrative production and distribution expenses reduce due to combination.

  1. Controls over Production

The combination is very effective in controlling overproduction. It helps to adjust the supply according to the demand.

  1. Large Scale Marketing

In the market, competition position is strong in bargaining. So it sells the product at a higher price.

  1. Experts Services

A combination can acquire the services of experienced specialists. It increases the efficiency of the combination.

  1. Research Work

A combination can spend money on research work, which is very important for the business. This research work reduces its cost and increases its profit.

  1. Use of Modem Technology

A combination is capable of using the latest inventions and new methods of production as a consequence of a transfer of technology. It will increase profit.

  1. Stability

A combination is a more stable form of business as compared to the individuals’ units. The chances of dissolution are also less than others.

  1. Division of Labor

The principle of division of labor is applied in combination, which increases the production efficiency of combination.

Disadvantages of Business Combination

Following are important disadvantages of combination:

  1. Creation of Monopoly

It creates a monopoly that is harmful to the people in the long run.

  1. The concentration of wealth

It concentrates the wealth in a few hands and divides society into few classes, such as rich, middle, and poor.

  1. Reluctant to be Accepted

The combination is disliked by the people, and it is not acceptable.

  1. Changes in Friction

The chances of friction among directors and officers are bright. They quarrel with, each other for their interest

  1. No Personal Contact

It is not possible to maintain direct contact between employees, creditors, and shareholders, due to this business may suffer a loss.

  1. Costly Management

A combination hires costly management, which increases the cost of production.

  1. Over Capitalization

There is always a danger of over-capitalization in the combination. It is harmful to the combination.

  1. Misuse of Funds

The directors of the company enjoy unlimited power and misuse the capital.

  1. National Interest Ignored

Generally, the combinations ignore the national interest, and they involved in such activities that are against the national interest.

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