(2024) A Level H2 Econs Essay Q1b Suggested Answer by Mr Eugene Toh (A Level Economics Tutor)

(2024) A Level H2 Econs Paper 2 Essay Q1b

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Introduction

Mergers and acquisitions (M&As) involve the consolidation of two or more firms into a single entity, typically with the aim of achieving various strategic objectives. While one key justification for M&As is to benefit from economies of scale, other factors such as increasing market share, gaining competitive advantage, or pursuing diversification may also be significant.

EOS as a justification for mergers and acquisitions
One primary benefit of M&As is the potential to achieve economies of scale, particularly internal economies of scale. When two firms merge or one acquires another, the newly consolidated firm operates at a larger scale, producing a higher output. This allows fixed costs, such as factory equipment, administrative expenses, or research facilities, to be spread across a greater level of production. Consequently, the firm’s average cost (AC) per unit decreases, increasing profitability.

For example, in the airline industry, if two airlines were to merge, the combined entity might benefit from technical economies of scale by utilising larger and more efficient fleets. This can result in increased profits as seen in the figure below where AC1 and MC1 reflects cost conditions of the larger merged firms, while AC0 and MC0 reflects cost conditions of an original individual firm. Profits will increase from P0ABC0 to P1CDC1

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However, achieving these economies of scale is not guaranteed. A well-documented case of failure to realise economies of scale is the AOL-Time Warner merger in 2000. Despite expectations of operational synergies, cultural clashes, technological misalignment, and poor strategic integration resulted in significant inefficiencies. Instead of reducing costs, the merger led to increased operating expenses, proving that economies of scale may not always materialise as anticipated.

Note: Students are to pick one of the following ‘other’ advantages to focus on

Other advantages of mergers and acquisitions - increased market share

Beyond economies of scale, firms often pursue mergers and acquisitions (M&As) to increase their market share, a strategic move that enhances their ability to set prices and reduce the intensity of competition. A larger market share provides the merged firm with greater control over the market, enabling it to exercise more significant influence over pricing strategies and market dynamics. This often results in increased supernormal profits, which can then be reinvested into various areas such as innovation, marketing, or expansion, creating a virtuous cycle of growth and competitive advantage.

For example, the Disney-Marvel merger in 2009 illustrates how M&As can increase market share and drive profitability. By acquiring Marvel, Disney gained access to an extensive portfolio of intellectual property, including iconic characters like Iron Man, Spider-Man, and Captain America. Leveraging Marvel’s storytelling assets, Disney successfully launched the Marvel Cinematic Universe (MCU), which became one of the most profitable film franchises in history. This increased market share not only resulted in massive box office revenues but also created synergies across Disney’s other business segments, including merchandise, theme parks, and streaming platforms. The MCU’s success also heightened barriers to entry for competitors, as Disney’s scale allowed it to outspend rivals on CGI, talent, and marketing, further entrenching its market dominance.

Increased market share also enables firms to strengthen their competitive positioning in the long term. A firm with a dominant market share can afford to reinvest its profits into research and development, leading to innovation that keeps it ahead of competitors. In the case of Disney, its ability to invest heavily in high-budget productions and emerging technologies, such as virtual reality experiences in theme parks, further cemented its position as a leader in the entertainment industry. By leveraging the increased resources and market influence from the Marvel acquisition, Disney not only maximised profitability but also expanded its competitive moat, demonstrating the far-reaching benefits of pursuing M&As to grow market share.

Other advantages of mergers and acquisitions - diversification
Another justification for M&As is the potential for diversification, which helps firms reduce risk by entering new markets or industries. Diversification allows firms to stabilise revenue streams by expanding their portfolio of products, services, or geographic markets, reducing dependency on a single source of income. This is particularly important in industries where technological disruption or market volatility could jeopardise a firm's core operations.

A notable example is Disney’s acquisition of 21st Century Fox in 2019, a $71.3 billion deal that significantly expanded Disney's portfolio beyond its traditional animation and family-focused entertainment. By acquiring Fox’s vast library of movies, TV shows, and cable networks, Disney gained access to new markets, particularly in adult-oriented content and international streaming. The acquisition diversified Disney’s offerings and bolstered its streaming service, Disney+, which now competes aggressively with Netflix and Amazon Prime Video.

This strategic diversification reduced Disney’s reliance on traditional revenue streams, such as theatrical box office sales and cable subscriptions, both of which face disruption from the rise of streaming services. Furthermore, the acquisition provided Disney with the rights to major franchises like X-Men and Avatar, strengthening its intellectual property portfolio, allowing the firm to generate revenue through merchandise, theme parks, and licensing deals.

In addition to reducing risk, diversification through the Fox acquisition allowed Disney to respond proactively to changing consumer preferences, such as the growing demand for on-demand streaming. By combining Disney’s family-friendly content with Fox’s broader range of genres, the firm positioned itself as a more competitive and versatile entertainment provider, creating new growth opportunities in domestic and global markets.