Hewlett-Packard (HPQ) on Tuesday said it will buy consulting firm Electronic Data Systems (EDS)
Horizontal integration—both HP and EDS are global consulting and technology services companies in the Information Technology industry, which are at the same stage of production
for $13.9 billion, including debt, an acquisition that will allow the computer giant to better compete with rival IBM.
Such a horizontal integration would allow substantial economies of scale to be reaped, lowering unit cost of production and hence make the firm more competitive.
Merger would mean a larger size of firm. Bigger firms have revenue advantages in terms of
-Pricing power (greater market share, demand more price inelastic.)
-Non-price Competition (advertising to create brand loyalty and make product more price inelastic)
And cost advantages in reaping substantial internal economies of scale.
The deal is a "reverse merger" that keeps EDS largely intact, says Shane Robison, HP's chief strategy officer.
HP's consulting unit, which has about 70,000 employees, will be rolled into EDS, which has about 140,000 employees. The combined entity will be known as "EDS — an HP company."
The large size of the merged firm can also be seen by the large number of employees, 210 000.
EDS CEO Ronald Rittenmeyer will run the new division. It will be based at EDS' Plano, Texas, headquarters, about 1,700 miles from HP's main office in Palo Alto, Calif. Layoffs are expected. "We're looking to streamline our overhead," Robison says.
One negative impact of mergers is the inevitable retrenchment and ‘layoffs’. However, rationalization has to occur. Reorganisation and restructuring of production have to take place to reduce duplication of managerial roles to increase productivity and reduce unit cost. The unit administration cost per output also decreases as it is spread over a larger output.
The new EDS will have about $38 billion in revenue and 5% of the fractured consulting services market, says researcher Gartner. IBM's legendary consulting division has about 7% of the market. "IBM is a formidable competitor, but the industry desperately wants a credible No. 2," Robison says.
When EDS merges with HP, it will have increased revenue and a larger market share, only 2% less than leader IBM. In this case leading firms in the IT industry seem to have a relatively small market share.
Possible market structure: monopolistic competition. Unlike in perfect competition, monopolistically competitive firms have products that are not perfect substitutes. Consumers have clearly defined preferences and sellers attempt to differentiate their products from those of their competitors, the goods and services are heterogeneous. For example, IBM and HP sell differentiated IT products with different features, yet neither controls a very large share of the market like in monopolies.
HP will pay $25 for each EDS share, stock option and restricted stock unit. HP will also assume about $3.3 billion in debt, while obtaining some cash and minority interests. (These amounts are included in the $13.9 billion purchase price.) The deal is expected to close in the second half of the year.
The news sent EDS shares up 1% Tuesday to close at $24.34. They jumped 28% Monday after HP revealed the negotiations. HP shares dropped 5.5% Tuesday to $44.27.
"It certainly makes sense," says Gartner tech analyst Allie Young. HP reaches thousands of business customers with its hardware and software products. EDS has greater expertise in business services.
Greater scope of specialization after merger since each firm can concentrate on what it does best. (Internal EOS) Specialisation will increase productivity and lower average cost of production
Together, "They could sell more services deals," she says. Economies of scale could also help cut costs. That's a concern for EDS, which has had accounting and profitability problems in the past. One of the biggest issues: a multibillion-dollar contract with the U.S. military that became a big money-loser.
Hint that EDS is earning subnormal profit (Total revenue < total cost) Merger with HP would allow for greater capital assets, sales revenue and market share. It will also reap internal economies of scale because fixed cost in such a capital intensive IT industry with high start up cost will be spread over larger outputs. This will lower unit cost of production, thus increasing profits. The LRAC of the merged company will fall over large outputs with a high MES. EDS may then be able to earn normal or even supernormal profits.
Robison says HP has spent more than 10,000 hours digging through EDS' financials. "We're very comfortable with the work they've done in the past two years to improve their cost structure," he says.
The acquisition is HP's largest since Compaq Computer in 2002. The "size looks daunting," American Technology Research equity analyst Shaw Wu said in a research note. HP's skill at combining the two companies will determine whether the deal is a success, Young says. Also Tuesday, HP released preliminary results for its second fiscal quarter. Revenue was $28.3 billion, up 11% from a year ago, thanks to "solid performance across HP's business segments," the company said. Earnings rose to 80 cents a share from 65 cents a year ago.
Issuing shares to the public is an cheaper alternative way to raise funds since there is no interest, as compared to borrowing from banks
In the current quarter, HP expects revenue of $27.3 billion to $27.4 billion. HP had planned to announce results Thursday but released them to coincide with the EDS news.
http://www.usatoday.com/money/industries/technology/2008-05-13-hp-eds-purchase_N.htm
there are many useful, easy to understand videos on youtube on drawing graphs for revision, here's one on first degree price discrimination, it can be linked to many more (:
here's a interesting song on elasticity of demand.
yuxi
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