Economies of Scale and Vertical Integration - Essay Example

? Financial Management Contents Introduction 3 Economies of scale 3 Economies of vertical integration 4 Combining complementary resources 4 Elimination of inefficiencies 5 Increased power in the market 6 Speed of growth 6 Financial benefits 7 Conclusion 7 References 9 Introduction Google Inc. announced an agreement to acquire Motorola Mobility on August 15, 2011. The deal was approved by the board of directors of both Google and Motorola. The deal was an example of a vertical merger where the software client, Google acquired the hardware client, Motorola. The deal was not an easy one for Google considering that the company had to put in a lot of effort for obtaining the regulatory approvals for the same (Reuters, 2012). The deal was announced at $40 per share which added up to a total of $12.5 Billion which was at a premium of 63% to the price of Motorola shares at the end of August 12, 2011. The acquisition of Motorola was aimed at protecting the viability of Google android considering the fact that Google was recently facing a threat due to patent war existing throughout the industry, due to which the major android manufacturers like HTC and Samsung were being sued by giants like Microsoft and Apple for the infringement of patents (Gaughan, 2011, p.5). Google announced that it will run Motorola as an independent business. The deal received approval from the shareholders as well as from the United States Department of Justice and the EU in early 2012. The approval from Chinese authorities followed and the deal was completed on May 22, 2012. The deal represented Google Inc.’s biggest challenge to Apple Inc., which was the leading player in the market of mobile phones and tablets. Economies of scale A vertical merger generally has a lower potential for economies of scale than a horizontal merger but the merger of Google and Motorola saw the achievement of economies of scale in both financial and risk bearing economies (The Economist, 2008). Technical, organizational, bulks buying as well as financial economies of scale were achieved from the merger (Thompson, 2012). Coordination improved in terms of cost fit, timing fit, size and communication fit within the business (Arnold, 2005, p.45). The merger immediately showed a success effect by increasing the market share in the world market for smartphones from 46.9% in the first quarter of 2012 to 68.1% in the last quarter of 2012. Economies of scale was achieved by getting other byproduct benefits such as the development of the next generation device for mobile computing, extra services, for example, advertising to living rooms through Motorola'scable TV boxes which helped in boosting the staggering set top box business, in smartphone designs aimed to fulfil the government regulations and competing with Microsoft’s new release of Windows phones. The company achieved a higher output with lowering the average cost, thus increasing the profitability and ensuring lower price for the customers (Rosenbaum, 2012). Economies of vertical integration The move to buy Motorola had a positive impact on the margins. Major phone manufacturers show a trend of having slim margins (Neale, 2004). But market leaders like Apple and Samsung have been known to maintain a margin of 40-50%. Google maintained net profit margin of 25% without having to subsidize the cost of manufacture in order to attract new clients. The merger showed a 100 to 150 basis points positive impact on the profitability. The merger enabled Google Inc. to supercharge the Android ecosystem and enhanced it competitive features in the mobile computing sector. The merger also opened up new opportunities for cross licencing. Combining complementary resources One of the main motives behind the merger was Google’s intention to accelerate innovation by combining the technical resources of Motorola Mobility. Another primary reason was that Google wanted to acquire the huge number of patents that Motorola had. The acquisition of these patents was likely to give the company a high competitive strength against its competitors, mainly Apple Inc. Google and Motorola Mobility had a high potential to accelerate innovation and choice in the mobile phone and smartphone market and their deal was likely to ensure that better phones at lower prices would be available in the market.This was because Google was considered a giant in software whereas Motorola Mobility was great at manufacturing devices. The combination of the two was likely to boost innovation in the market. Motorola Mobility had a strong foothold on the innovations in communication technology and in the development of intellectual properties. Google can manufacture hardware in large quantities. Motorola was once a major mobile manufacturer. The sale of mobile phone model Razr exceeded 100 million units. Among the OEM’s, Motorola was holding a market share of 13.7% in 2011. The company later decided to manufacture mobile phones using the Android operating system, with the expectation of a strong market reception based on its reviews. Google Inc. plugged the resources from Motorola Mobility into the existing business model of Google and saw a huge improvement in the functionality of the business (Varma, 2012). The company expanded its business into mobile phones and the television and internet business through the merger. It also opened up the way to distribute the Android operating system software through mobile phones and build the market for the Google TV and the chrome browser. Elimination of inefficiencies Google Inc.'s acquisition of Motorola Mobility Holdings brought a substantial amount of tax and accounting benefits for the company. Google Inc. was already known to be a savvy user of the tax benefits in the corporate world of America. The deal also started the trend of technology companies to get into mergers and acquisitions with the major objective of acquiring patents so as to offset patent infringement law suits and threats from competitors. Google's patent portfolio was seen as one of the weakest in the industry (The Wall Street Journal, 2012). The deal ensured access to Motorola's extensive range of acquired patents and more than 7500 pending patent applications along with the mobile handset business and television set-top boxes business, thus eliminating the weaknesses of patents for Google as well its constraint in being trapped in the hardware industry alone. Increased power in the market The deal of acquiring Motorola Mobility gave Google access to a strong base of more than 1700 mobile phone patents, thus Google was empowered to plan for the development of newbusiness strategies after the acquisition was done.The acquisition of Motorola strengthened Google's position in a market that was facing a number of intellectual property battles. On the other side, this also strengthened the position of Android as an operating system platform. The Android operating system was used in 56.1% of all smartphones sold in the first quarter of 2012 which was more than that of Apple’s iOS operating system which was 36.45 of the smartphone market throughout the world. Nokia’s Symbian operating system had 27% market share in the last quarter of 2012. Thus, Google had a much stronger position in the market than its competitors in this quarter (Chapman, 2012.). The merger helped Google meet the objectives of creating a market entry barrier and strengthening its position in the competition with Apple Inc. Speed of growth The company saw unexpected growth in revenues and margins after the merger.Manufacturing being a new concept to Google, the company saw a lower speed of growth in production following the merger. After the deal was closed, Google restructured the Motorola business substantially to make it fit to the business model of Google. Google announced plans to Layoff 4000 Motorola employees and in the last quarter of December, Google sold off the manufacturing operations of Motorola to Flextronics under an agreement the Flextronics will manufacture undisclosed mobile devices on the Android platform. Google also sold the Motorola Home business division to Arris Group for $2.35 billion in a cash-and-stock transaction from which the company acquired a 15.7% stake in Arris Group which was valued at $300 million (Forbes, 2103). Financial benefits Google experienced the best of its kind advantages from its alliance with Motorola. By acquiring Motorola, Google Inc. paved the way for taking a tax advantage till 2019.The deal highly impacted the stock prices of Google Inc. and Motorola as well as the other players in the market. The revenues of Google Inc. rose from $10.8 billion to $17.5 billion. When Google announced its merger with Motorola Mobility Holdingsthe impact was immediately noticed on the stock prices of both the companies. Google paying $40 per share ofMotorola which was at a premium of 63% resulted in the increase of the share price of Motorola Mobility by almost 60% with a value of $38on the week after the announcement rising from around $24 per share before. Google’s stock price rose from $600.80 to $ 801.42 within a year of the closing of the deal (Reuters, 2012). Conclusion After the announcement of the deal of Google Inc. acquiring Motorola Mobility, the impact was seen on the other players in the market like Microsoft and Apple. The deal of Google acquiring Motorola shifted some manufacturers using the Android platform to Microsoft's Windows phone platform. The Google Motorola deal was done to give Google a competitive edge over Samsung and Apple in thehardware business. Another goal was to compete with the strong market share of Apple Inc. 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