The term business consolidation refers to the combination of different business units or companies into a single, larger organization. Business consolidation is a legal strategy that is often initiated to improve operational efficiency by reducing redundant personnel and processes. Often associated with mergers and acquisitions (M&A), business consolidation can result in long-term cost savings and a concentration of market share no matter how expensive and complex it may be in the short term.
There are various types of business consolidation, including statutory consolidation and variable interest entities.
KEY TAKEAWAYS
- Business consolidation is a combination of several business units or companies into a single, larger organization.
- The reasons behind consolidation include operational efficiency, eliminating competition, and getting access to new markets.
- There are different types of business consolidation, including statutory consolidation, statutory mergers, stock acquisitions, and variable interest entities.
- Consolidation can lead to a concentration of market share and a bigger customer base.
- Some of the disadvantages of consolidation include dealing with cultural differences between firms and potential issues with personnel.
How Business Consolidation Works
Consolidation happens when two or more companies merge to become one. Also known as amalgamation, business consolidation is most often associated with M&A activity.1 This generally happens when several similar, smaller businesses combine to form a new, larger legal entity. In most cases, the smaller entities cease to exist after being swallowed up by the acquirer.
Combining multiple companies or business units into a brand new entity is the most drastic option. This may be an expensive proposition if one of the merging companies is liquidated. The process may carry additional costs associated with creating a new brand. But businesses that want to consolidate their operations have other options at their disposal, including the movement of smaller operations into an existing company that won’t be dismantled.
The reasons behind consolidation vary, and there are many. They include but aren’t limited to:
- Operational efficiency
- Eliminating the competition for customers and/or resources
- Access to and expansion into new markets
- Innovation and new products
- Cheaper financing options for bigger businesses
- Shared operations
- Increased revenue
Regardless of the rationale, businesses can’t and shouldn’t take the decision to consolidate lightly. Not only are the costs associated with consolidation fairly heavy, but there are also other things to consider. For instance, executives and other key personnel have to satisfy the concerns of shareholders, they must consider what happens with workforce redundancies, whether to sell assets, and how to market and brand the new company once the whole process is complete.
There are antitrust laws and regulations in place to discourage monopolies that may arise as a result of business consolidation.
Types of Business Consolidation
Just like company types, there are many different kinds of business consolidation. It all depends on the strategy, the desired outcome, and the nature of the businesses involved.
- Statutory Consolidation: When businesses are combined into a new entity, the original companies cease to exist. By combining them together, they create a new, larger corporation. As such, statutory consolidation is normally done through a merger.
- Statutory Merger: This kind of business consolidation occurs when the acquirer liquidates the assets of its target. Once done, the acquirer incorporates or dismantling the target company’s operations. Unlike a statutory consolidation, the acquiring company keeps its operations going, while the acquired entity no longer exists.
- Stock Acquisition: This is a combination of businesses in which an acquiring company buys a majority share or a controlling interest of another company. In order for it to be a majority share, the acquirer must buy more than 50% of the target. Both companies end up surviving.
- Variable Interest Entity: When an acquiring entity owns a controlling interest in a company that is not based on a majority of voting rights, it is referred to as a variable interest entity. These entities are normally established as special purpose vehicles (SPVs).
Advantages and Disadvantages of Business Consolidation
There are many advantages to combining two or more business entities together. But with the positives, there also comes a lot of negatives. We’ve listed some of the key pros and cons for this business strategy.
Advantages
As noted above, combining businesses or business units into a larger entity often increases the new company’s bottom line. This means it may be able to cut costs and boost revenue. The new company may also be able to use its larger size to extract better terms from suppliers. That’s because it is more likely to buy more units to satisfy a larger consumer base.
Newer, smaller, and/or struggling businesses may have problems getting access to capital in order to grow. But consolidated businesses may have an easier time obtaining financing—often at cheaper rates. This is especially true if the newly formed entity is more stable, more profitable, or has more assets to use as collateral.
Business consolidations can result in a concentration of market share, a more expansive product lineup, a greater geographical reach, and therefore a bigger customer base.
Disadvantages
Companies that combine operations must deal with cultural differences between firms. For example, merging an older, established technology company with a small startup company may achieve a transfer of knowledge, experience, and skills, but it may also lead to clashes. The older firm’s management may feel more comfortable with strict corporate hierarchies, while the startup company may prefer less administrative authority over operations.
Some businesses may find that their synergies are well-suited for consolidation. But that may backfire if one or the other has far too much debt. Consolidation, therefore, may increase the new company’s debt load. If not addressed, it can be problematic for the company’s management and, ultimately, its shareholders if the company is public.
While it may lead to cost-cutting and increased revenue, business consolidation does have a negative economic effect. That’s because it often leads to redundancies in the workforce, which often ends in layoffs and unemployment, even if not on a major scale.
Pros
- Cut costs, boost revenue, and get better terms from suppliers
- Easy access to (cheaper) financing
- Larger market share, product line, geographical reach, and customer base
Cons
- Cultural differences between firms
- Increase in debt load
- Redundancies in the workforce often lead to layoffs and unemployment
Example of Business Consolidation
As noted above, the process of business consolidation is often associated with mergers and acquisitions. To show how it works, let’s use a hypothetical example. Suppose Company 1 (the larger company) decides it wants to acquire smaller rival Company 2. Shareholders, management, and the board of directors of both companies all approve of the deal. Once the consolidation takes place, both companies operate under Company 1’s name while Company 2 ceases to exist.