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Horizontal Merger

Page history last edited by PBworks 16 years, 3 months ago

 Horizontal Mergers

 

Economics

Teacher: Mr. Gawron

Group Members: Anthony Butler, Channan Reiblat, Shawn James

Period 12

 

Introduction


 

      A horizontal merger occurs when two or more companies that offer similar services or products join together to form one major corporation. After merging, the new corporation creates economies of scale and scope, thereby increasing productivity and offering consumers better services. On the other hand, mergers can substantially lessen competition by forming a monopoly or oligopoly through the process of horizontal integration, and are subject to regulation by the United States Federal Trade Commission (FTC). Large corporations that merge, such as Sprint and NEXTEL which merged to become Sprint Nextel, have a major effect on economy because they create mutual dependencies (see  "drawbacks" section) on other companies and alter competition.
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Case Study: Sprint and NEXTEL


        In 2004, Sprint and NEXTEL, two of the five major mobile phone companies at the time, proposed a merger in which they would become one major telecommunications firm, cornering over three fourths of the market along with Cingular and Verizon Communications.

        In an effort to compete for more consumers in the extremely aggressive mobile communications market, the two companies would merge into the Sprint Nextel Corporation and combine previously separate offers such as the popular "Fair and Flexible" plan and “Push to Talk”, in turn allowing the consumer's dollar to go farther than it has ever gone before. Subsequently, by merging, the Sprint Nextel Corporation would become the number three telecommunications firm in the United States, bringing better "mobility to consumer, business, and government customers", which would put pressure on its main competitors, Cingular and Verizon Wireless.

       On the other hand, while some praised Sprint and NEXTEL’s efforts, others criticized the deal as an attempt by Sprint and Nextel to create an oligopoly in the telecommunications market through monopolistic competition. From a shareholders perspective, NEXTEL shareholders criticized the merger because it would cost them a nine percent premium and a sixteen percent stock value loss, while Sprint gained twenty six percent in stock value and with no premium. Claiming that the merger between Sprint and NEXTEL was not in fact “a merger of equals”, many believe the merger was an attempt by Sprint to buy out NEXTEL, further expanding its broad reach in the mobile phone market.

 

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                                                                   "Sprint Nextel Merger Advertisement"

 

 

 

 

 

Advantages of Horizontal Mergers


        According to Adam Smith, who is considered by many to be the father of modern economics and the author of The Wealth of Nations, when two companies such as Sprint and NEXTEL horizontally merge they are able to create economies of scale. An economy of scale is exists when a company can produce more goods or services on a larger scale, but with less cost. By implementing the techniques of division of labor and specialization, Sprint Nextel employees would focus on specific tasks, and in turn do a better and faster job, creating efficiency. Through efficiency, Sprint Nextel would minimize cost while maximizing product output, creating an economy of scale. An example if this can be seen with the new “Wi-Max” network which costs Sprint Nextel significantly less to utilize than its competitor, “CDMA”, another network. By specializing in this specific network Sprint Nextel cuts cost while using the money saved to create more phones on the network and increase production.

Similar to economies of scale, economies of scope bring together multiple business ventures simultaneously, creating more cost effective and efficient performance than when the businesses stand alone. Sprint Nextel creates an economy of scope because under the one brand there are many distinct services and goods. For example:

  • "Embarq"- Fourth largest local telephone company in the United States. (Formerly a Sprint brand, but recently it has become independent.)

  • "Sprint Video Relay"- Provides video relay services to the deaf and those who are hard of hearing through a sign language interpreter.

  • "Sprint Music Store"- Provides music enabled cell phone users with digitally downloadable music and streaming satellite radio.

 

 

 

    Ultimately, by horizontally merging and creating an economy of scope and of scale, Sprint Nextel is able to provide better services and goods for the consumer by bringing the best of both brands together at more affordable price to the consumer. For example, when the merger was completed Sprint Nextel decided to combine NEXTEL's technological capabilities such as "Push to Talk" and "Windows Mobile 5.0" with Sprints high speed network to create the PPC-6700, a pioneer in buisness oriented phones. In conclusion, horizontal mergers allow companies to increase output while decreasing cost, passing along better services and goods to the consumer at a more affordable rate.

 

 

Drawbacks of Horizontal Mergers

 


Oligopoly, derived from the Greek words “oligo” (few) and “poly” (sellers), means to have a market place dominated by a few sellers. In a market where Sprint can forcibly acquire three separate mobile phone carriers in less than a month, Sprint fits the classical definition of an oligopoly because it effectively reduces the number of firms in the mobile phone industry. Since merging with NEXTEL, Sprint Nextel has taken over ten previously independent companies by force, including “Ubiquitel” and “US Unwired”, which were billion dollar corporations.  

While Sprint Nextel may seem like monster with a never ending appetite for smaller competitors, on the worldwide scale, Sprint Nextel is a part of the “Big Business” that is mobile communications along with "at&t", "Verizon", and "T-Mobile". Specifically, the four major competitors can be considered a pure oligopoly, because they sell very similar products including cell phones and calling plans. Because there are so few competitors in the market, each is aware of the others actions, causing mutual dependence. A key trait to an oligopoly, mutual independence means that when one firm does something, the others are forced to make nearly identical decisions to ensure a strong hold in the market. An example of this can be seen when at&t released the extremely anticipated "iphone" on June 29th, 2007, only to be followed by the Voyager, Verizon's almost identical copy.

             As seen in the previous example, cell phone companies ruthlessly compete with each other, constantly cutting prices and offering nearly identical products in an effort to attract more consumers. From the consumer standpoint this may seem good, but by analyzing the economic effects of this cycle it can be seen that the major cell phone companies are in war against each other, while simultaneously shutting out any competition from new startups that wish to break their grasp on the market. With the billions of dollars invested in advertising, it would be nearly impossible for a new company to stand out amongst the "big four", and even if it did it would probably be bought out or forcibly acquired. Also, it is very hard for a company to leave the market because it can cause a lot of economic problems, such as throwing of the price equilibrium, the point where supply meets demand. In conclusion, horizontal mergers such as the one between Sprint and NEXTEL can lead to oligopolies which foster aggressive competition and mutual dependencies that shut out any new competitor interested in entering the market.

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While exaggerated, this video shows how ruthless the competition between cell phone companies can be.

 

Summery of Issues

  • Horizontal mergers create economies of scope, which bring together multiple business ventures simultaneously, creating more cost effective and efficient performance than when the businesses stand alone. Sprint Nextel creates an economy of scope because under the one brand there are many distinct services and goods.
  • Horizontal mergers create economies of scale, which occur when two companies such as Sprint and NEXTEL horizontally merge and produce more goods or services on a larger scale, but with less cost.
  • Because of the merger Sprint Nextel is able to provide better services and goods for the consumer by bringing the best of both brands together at more affordable price to the consumer.
  • Horizontal mergers create oligopolies, which are markets dominated by a few sellers. Sprint fits the classical definition of an oligopoly because it effectively reduces the number of firms in the mobile phone industry. Since merging with NEXTEL, Sprint Nextel has taken over ten previously independent companies by force, including “Ubiquitel” and “US Unwired”, which were billion dollar corporations.
  • Because there are so few competitors in the telecommunications market, each is aware of the others actions, causing mutual dependence. A key trait to an oligopoly, mutual independence means that when one firm does something, the others are forced to make nearly identical decisions to ensure a strong hold in the market.
  • Because horizontal mergers cause oligopolies that dominate the market with billions of dollars invested in advertising, it would be nearly impossible for a new company to stand out amongst the "big four" (at&t, Verizon, Sprint Nextel, and T-Mobile), and even if it did it would probably be bought out or forcibly acquired.

 

 

Personal Responces

 

 

Anthony's Response

 

Just about three years ago, Sprint and Nextel came together as one communication carrier, to try and dominate the cell phone market. The question is did they succeed? Well they defiantly pleased the market in my opinion, by introducing the Sprint phone service, and the Nextel walkie-talkie, together in one phone. It’s obvious that the two companies mastered the merge by coming together as one carrier, but what’s really going on, inside of this company that no one knows about?

     After Sprint and Nextel combined, a team of analysists researched what each company put into the merger. What they came up with was “Sprint’s shareholders didn’t have to pay any premium, and will retain the shares they hold. On the other hand Nextel’s shareholders had to put out 9% of a premium”. By December 14, 2004 Sprint Nextel was trading 30% below its median. Its competitors AT&T went up 60%.

Economically the price planning Sprint Nextel came up with was terrible, “the company stumbled in 2006 when it introduced low-cost pricing plans to entice new customers. The deals were instead pounced on by existing subscribers, who used them to reduce their monthly bills”.

     It is my belief that Sprint Nextel has as a long ways to go due to the huge turn around the company will have to make in order to be on top of the market as inspected from the CEO’s, and Chair’s of the company. It seems as “Sprint and Nextel can’t get the little things right”. This company will have to investigate its interior problems, and make necessary repairs in order to keep up with its competitors. 

 

Chanan's Response to Horizontal Mergers

 

While horizontal mergers may seem to have the benefits of scope and scale, in reality they hurt the economy and the average consumer because it leads to an entire industry being controlled by an elite group of companies that can collude to guide prices and competition to their own benefit. Because the elite firms are mutually dependant they all fight against each other for customers and in turn which prevent any new company from entering the market because it can’t compete with the billions of dollars being spent on ad campaigns and new services. As a firm supporter in the right to entrepreneurship, I believe that the oligopolies created by horizontal mergers stifle the market as well as the independent spirit that guides America’s most successful companies. If the major companies controlling a certain industry, such as mobile telecommunications, are all doing a sub-par job and not allowing anyone else to enter the market who is the consumer expecting to see change? As the old adage states, the “blind lead the blind.”

                When it comes to the specific case of Sprint Nextel merger, I believe that when an industry is divided up into four major companies that control almost all of the production there is an adverse affect on competion. This adverse effect can be seen in mutual dependence, which hurts the consumers more than it helps. Rather than produce their own unique products and services, at&t, T-mobile, Verizon, and Sprint Nextel simply copy and undercut each other through petty scams in effort to get more customers, often with lack luster results, LG's "Prada" being one example. In terms of being successful, Anthony and Shawn are looking at the merger from too narrow a perspective, and are missing the bigger picture that Sprint Nextel is homogenizing the market and turning into an oligopoly. While on a small scale the merger may offer some better services to consumers, in the longs run it hurts them because of collusion between the major cell phone carriers due to their mutual dependencies.

 

 

Another aspect of horizontal mergers that I find detrimental to the economy is when members of an oligopoly collude to set price controls and use industry as a weapon. An example of this can be seen in the OPEC oil embargo of 1973 which led to a nationwide crisis.

As a response to the Yom Kippur war occurring in Israel, the Organization of Arab Petroleum Exporting Countries (OAPEC), which is the product of a horizontal merger of Middle Eastern petroleum exporters, imposed an embargo against all countries supporting Israel, namely the United States. Exploiting the world’s dependence on crude oil, OAPEC took advantage of its oligopoly in the petroleum market. By doing so OAPEC “engaged in some form of coordination on price, output, capacity, or other dimensions of competition.” which is detrimental to the economy according to  the U.S department of Justice and the Federal Trade Commissions. The OAPEC oil embargo is only one example of how horizontal mergers lead to so much economic power being concentrated in the hands of the few, and if they are not prevented companies like OAPEC will exploit their power and hurt consumers and economies worldwide.

 

 

Shawn's Response

 

    Horizontal mergers are businesses that get together to create one business that most likely dominates its competitors. In most cases these businesses are successful such as Sprint and Nextel or AT&T and Cingular. That’s why my personal perception of merging is positive. Also referring to Sprints merge with Nextel, the two companies are satisfying everyone’s wishes because they combined the walkie-talkie and the unlimited minutes after 7 o’clock features all into one package for a low price which lead to more customers. According to Social Science Electronic publishing, the managers of firms going through with horizontal mergers and acquisitions (M&A) have realized improvements in production efficiency as a primary source of gains in the transactions. The Antitrust authorities thinks that horizontal mergers allow the firms to gain at the cost of customers or suppliers by exercising increased market power. The paper examines the possibility of gains in the case of horizontal mergers by the organizations.   

 

Online Resourses

  1.  “Sprint Nextel Completes Acquisition of Nextel Partners.” Sprint Corperate. June 2006.

                <http://www2.sprint.com/mr/news_dtl.do?id=13160.>

     2.   "Horizontal Mergers." Learn Mergers. 10 December 2007.

               < http://www.learnmergers.com/>

     3.    "MERGER: Nextel to sprint." Iclub News.  17 August  2005

               <http://www.iclub.com/support/kb/default.asp?page=kb_1021>

 

     4.    "Sprint, Nextel in $36B merger." CNN Money News. 15 December  2004

               < http://money.cnn.com/2004/12/15/news/fortune500/sprint_nextel>

 

     5.     Rotheman, Wilson. "Wireless, Thin and Smart". Time Global Buissness News. 10 October 2005.

               <http://www.time.com/time/magazine/article/0,9171,1115687,00.html>

 

     6.     Mcdonald, Duff. "Sprint meets Nextel". Portfolio News. December 2007.

               <http://www.portfolio.com/news-markets/national-news/portfolio/2007/11/19/Sprint-Nextel-Merger>

 

     7.     Heakel, Ream. "What are economies of scale?" Investopedia. 10 December 2007.

 

               <http://www.investopedia.com/articles/03/012703.asp>

 

     8.     O'shea, Dan. "Sprint buys two affiliates; Alamosa lawsuit pending." Telephony Online. 12 December 2007.

               <http://telephonyonline.com/mag/telecom_sprint_nextel_buys/>

 

     9.    "Analysis of the Strategic Behavior of an Oligopoly." Referaty Seminarky. 12 December 2007.

               <http://referaty-seminarky.sk/an-analysis-of-the-strategic-behavior-of-an-oligopoly/>

 

    10.   "Sprint Nextel." Wikepedia. 13 December 2007.

               <http://en.wikipedia.org/wiki/Sprint_Nextel#Affiliate_acquisition>

    11.   "1973 Oil crisis" Wikepedia. 13 December 2007.

                <http://en.wikipedia.org/wiki/1973_oil_crisis>

 

Suggested Further Reading

 

 

 

 

 

 

 

Comments (2)

Anonymous said

at 10:26 pm on Nov 7, 2007

Looking at the two I would say that going with the Sprint/Nextel would be the better case study because it was a successful horizontal merger, while the other would be used a a potential con of horizontal mergers because it could create monopolies, etc. Obviously there needs to be more detail regarding what each party brought to the table in the merger and the end result. You have the tip of the iceberg, now you need to delve a bit deeper.

Anonymous said

at 10:35 pm on Nov 8, 2007

Already discussed this, keep up the work.

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