One of the motives behind mergers and acquisitions is to exploit market imperfections. I don't understand, can someone please explain how this works?

Question

One of the motives behind mergers and acquisitions is to exploit market imperfections. I don't understand, can someone please explain how this works?

Answer 1

A free market's goal would be to have competition. So that would mean that in my city, there should be multiple cable and internet providers, multiple cell phone service providers, multiple grocery stores, etc. When a merger occurs, like the one proposed by T-Mobile and Sprint, the companies involved see a benefit to themselves by combining. Example: Verizon is No. 1 in cell phone service, with T-Mobile second on many tests, rankings, etc. T-Mobile is behind Verizon mainly because T-Mobile's rural service is bad, and Verizon's is consistent. Sprint does well in rural areas, but not very many other areas. Sprint also will not likely survive on its own for much longer. Both companies benefit with a merger into one ( a new T-Mobile). The gap that was exploited here, is that ideally the market would not have allowed Verizon to become so powerful, but because markets are not perfect, Verizon has become a powerhouse.

-Cory

Answer 2

Khu, thank you for asking. While many proposed questions sound like ethic questions (e.g. ‘exploitation’ usually means a sinister, abusive intent), it may depend upon how one defines ruthlessness, opportunism, and the desire to avoid/acquire competition. Other valid concerns may be: how should one grow their business: organically or through acquisition?

How do you define “market imperfections”? Does this mean a matured market primarily staffed by companies who are no longer innovative? Or may it mean markets with little to no competitive spirit which are ripe for a newer, nimbler competitor who is willing to mix it up a bit?

While it sounds offensive or corrupt, “exploiting market imperfections” may be a poorly-worded choice which means a well-organized, ethical company desires to (1) acquire other players to lessen competition or (2) acquiring similar companies in under-developed or under-competitive markets so they may arbitrarily increase your own market share.

Another a real-world example: Disney reissues/re-releases their entire film collection every seven years. During each ‘re-release’ they advertise ‘this is the last time this film will be release on Beta’ or ‘VCR formatting’ or ‘last time on DVD’ or ‘last time on Blue Ray’. 

They have pulled this trick for since the 1980’s. The wording of their marketing creates a scare tactic in young parents to buy as many Disney releases as possible for themselves (and possibly yet to be born grandchildren).

Disney pulls this ‘marketing exploitation’ based on the premise their ideal audience rotates every seven years. Meaning, a four-year old to an eleven-year-old may watch the same movie; however, during the teenage years their audience taste’s dramatically change. The ‘never to be release again’ mantra Disney is referring to known technology may change every seven years.

Thus, Disney’s ‘last time’ reference means last time on Blue Ray – knowing full well the next release seven years from now will be on a different, improved format. They arbitrarily create demand by exploiting fear. Whether this is like your ‘market exploitation’ definition is debatable. Unfortunately, it is practiced in our business climate.