Make-Or-Buy Decision

Finance allah shmoop what are the economics of ah good

merger Well you have a baby and they cost a

fortune You know food clothing diapers school await a different

kind of merger Sorry moving on In a purely financial

sense a merger is the coming together of two companies

such that in theory at least the sum of the

one plus thie Other one will be more than two

And there are a few perspectives that outlined the strategy

behind a good merger Let's start with market share or

market leadership to home coffee roaster making companies combine each

owned about twenty percent of the market before the merger

And together we'll now together Yeah together they own forty

percent instead of rivalrous lee competing against each other for

shelf space and marketing keywords on google in suppliers of

boilers Now the two companies air now the undeniable leader

and that vaunted position gets them a bunch of quote

freebies unquote freebies free They're free and they're not competing

against each other anymore They're a team like they don't

undercut each other on price right So immediately they could

raise prices Yeah so think super friends in this and

how good the coffee must be at the hall of

justice So what are these freebies they get just by

being big Aii the market leader in revenues and our

units sold Well what do they get for being the

big kid on the block Well one freebie is that

whenever a journalist writes a story about a coffee roaster

for home use often in the starbucks haters gazette that

journalist almost has to get a quote from mega brew

inc You know or that journalist story really isn't validated

It would be like writing a story on internet search

and not getting a quote from google So lots of

free press comes their way like you know free marketing

and as part of the process in being vey brand

While the company likely raises the ceiling on pricing Before

the merger one product was six hundred ninety nine ninety

five and the other was maybe six hundred forty nine

ninety five and claimed we do what there's does for

five pounds of raw coffee les or something like that

Yeah we didn't write this loving but now instead of

competing against each other on price or why not just

raze overall prices of everything to seven hundred forty nine

ninety five Who's going to stop Yeah you're the market

leader the big dog So now with the exact same

cost structure the company has fifty to one hundred bucks

more per unit in a pretty much immediate profit And

if before the unit profit was something like seventy eighty

ninety hundred bucks while profits just gone up dramatically So

that's the story on the revenues side What about on

the expensive side Well a couple of biggie stand out

immediately Kwan is the cost of supplies like if combined

they were each ordering one hundred thousand five hundred fifty

degree blowing many easy bake oven units and paying the

maker of those units one hundred fifteen dollars a unit

now under the scale of an order of two hundred

thousand units Well taken likely get a price break of

ten maybe twenty bucks a unit and those savings happen

all the way down the whole building Materials from the

power cord to the glass shields to the plastic form

factors to the little rotating spinny wheel thing that has

the beings going round and round So in a set

of unit costs of say two hundred fifty bucks a

unit for the hardware A new home coffee roaster might

under the combined company's cost them more like two hundred

bucks Then there's the cost of shelf space or distribution

Or if you want to think about it kind of

marketing When the two twenty percenters were competing against each

other well they'd negotiate for the prime shelf space at

upscale coffee bars gourmet kitchen retailers and amazon for that

physical or virtual shelf space Right And they'd negotiate on

how much of their revenues they were willing to give

up in order to get that premiere shelf space Well

that was with the two of them living in a

world where switching from one brand to the other was

pushed there about equal But now there's only one dominant

brand and it's the one everyone who roasts at home

wants So instead of giving up fifty percent of revenues

for distribution well now they only have to give up

forty percent So think about the cascade effect here The

average retail price used to be say six hundred eighty

bucks a unit How'd we get that number And we

what kind of an average of that Six forty nine

six ninety nine Numbers so on that 6:80 the company

kept in half or three hundred forty and that three

forty was enough to cover their costs but not leave

a whole lot of cash left over By the time

everything i'ii operating cost marketing lawyers insurance rent lawyers was

done and paid for But now average retail prices have

gone to seven hundred fifty dollars And instead of keeping

half the combined company now keep sixty percent of the

retail price or four hundred fifty bucks Huge swing here

That's an incremental keep or take or profit set of

one hundred ten dollars in the form of higher prices

and splits and then another fifty bucks in cost savings

per unit for an incremental total contribution of another hundred

sixty dollars a unit And in a world where each

unit contributed maybe forty bucks in the past this is

a massive game for shareholders of mega brew and just

like their commercial says But wait there's more In addition

to these units savings and values added the company should

they need it can probably get debt cheaper All else

being equal as a market leader They in theory at

least carry less risk They certainly have more have to

be able to borrow money And a bigger scale in

a borrowing of say twenty five million dollars would mean

less to them is a combined company than would a

borrow of twenty five million work if each company were

separate and still competing against each other and the same

scale benefits happened for duplicate jobs were taken likely fire

a third or more of their workforce and negotiate for

better per square foot prices from their landlords and better

insurance and better lawyer rates And so on Well it

all adds up to make this merger a you know 00:05:36.102 --> [endTime] special kind of blend