Introduction
In the current business environment, the primary objectives of organizations are profit-making and sustainability of performance in the short and long-term. Over the years, mergers and acquisitions have been deployed as an external growth strategy. This strategy has gained momentum as a result of increased privatization, liberalization, deregulation, and globalization in most sectors of the business arena. This paper examines the impacts of merger and acquisition events on the sustainability performance of merged organizations with reference to the Indian Aviation Industry.
Mergers and Acquisitions on the Sustainability Performance
Notable Mergers and Acquisitions
Mergers and acquisitions as a form of business consolidation have gained popularity across the major global industries such as telecom, aviation, banking, and automobile. For example, the renowned mergers and acquisitions are Benz and Chrysler, SBC and AT&T, and Air France and KLM (Lozano 2013). Several research activities have been carried out on the benefits and demerits of mergers and acquisitions. Specifically, as noted by Kim et al. (2014) and Jassem, Azmi, and Zakaria (2018), the news of a potential merger or acquisition is often sensitive and can immediately result in a sharp rise or decline in share prices for the involved companies
Across the globe, firms enter a merger and acquisition with other organizations that are in the same line of business or related sector as part of diversification. For instance, in the case of the Benz and Chrysler merger, both firms benefited from the expanded market in luxury vehicles and improved efficiency in the cost of production (Kim et al. 2014). In the post-merger, the cost of production for Chrysler and Benz’s brands reduced by 5%. Moreover, the two firms have been able to improve their financial standing in the global automobile industry. Due to this merger, the Benz-Chrysler brand has assumed the first position in the global luxury automobile industry.
Herbohn, Walker, and Loo (2014) and Harrison and Wicks (2013) concur that companies entering into mergers with firms that are diversified are positioned to explore and exploit a myriad of advantages that were not available in the previous business model. Since diversification involves the expansion of operations into other industries or sectors, firms that enter into a merger and acquisition are likely to gain from diverse portfolio balance (Jassem, Azmi & Zakaria 2018). For example, as noted by Hahn and Kühnen (2013), the business environment risks are spread and absorbed by two or more establishments as compared to a single entity. Based on these examples, there is a need to examine the actual impacts of mergers and acquisitions within a focused industry. The proposed study concentrates on the Indian Aviation sector by examining mergers and acquisitions involving Jet Airways-Air Sahara and Kingfisher Airlines-Air Deccan.
Literature Review
A merger occurs when organizations come together to proactively share resources with the aim of achieving common objectives. In a merger, the combining firms create a third entity with the partners remaining as joint owners of the new venture (Herbohn, Walker & Loo 2014). On the other hand, Cheng, Loannou, and Serafeim (2014) note that acquisition occurs when one company takes full control of ownership from another firm.
Strategic Dominance and Efficiency
The primary factors influencing mergers and acquisitions are changing economic and social business environments. Basically, Al-Zwyalif (2017) and Bal et al. (2013) concur that mergers and acquisitions are aimed at improving strategic dominance and efficiency in the factors of production for optimal gain. Efficiency elements guarantee increased gains from economies of scale and scope. In the practical business environment, the economies of scope and scale are achievable through a proactive process of integrating efficiencies and business volumes for the merging firms. On the other hand, the strategic gain is influenced by a paradigm shift in the business and capital structures of the two or more firms coming together (Harrison & Wicks 2013). As a result, the growth of profit would be positive, especially in the long-term. Mergers and acquisitions also promote synergy, which is a state of cooperation for optimal gain.
Through mergers, the combining organizations will expand their resources and expertise for better performance (Al-Zwyalif 2017). For instance, a synergy associated with value creation may improve the capital structure. Moreover, it will improve investor confidence and ensure that the post-merger is sustainable from all business aspects (Herbohn, Walker & Loo 2014). In the mergers and acquisitions, there are financial, managerial, and operational synergies that boost performance. The operational synergies consist of resources that complete the production cycle and other administrative efficiencies. This means that firms participating in mergers or acquisitions have diverse factors of production to ensure that operational management is both effective and efficient. For instance, a combination of production resources, technologies, and strategies through mergers would result in stable logistical support, which translates to better performance (Alewine & Stone 2013). When properly integrated, Hahn and Kühnen (2013) and Alewine and Stone (2013) note that operational synergies would result in a strategic combination of two sets of economies of scale for each organization into a single unit. As a result, the average production costs will reduce through efficient resource utilization and ensure that every bundle of inputs results in optimal outputs.
According to Rashid and Naeem (2017), the financial synergies explain the reduced cost of capital through mergers and acquisitions, thus increased borrowing power for the newly formed business entity. Through a systematic focus on financial synergies, Hahn and Kühnen (2013) concur that merging businesses have the potential of increasing their competitiveness, especially when the entities operate in the same sector. For instance, the merger between KLM and Air France has made it one of the most competitive global airline brands in the current aviation industry. This means that financial synergies have the potential of proactively making an individual capital unit to achieve optimal results as compared to the situation before the merger or acquisition (Cheng, Loannou & Serafeim 2014). The resulting financial diversification carries with it advantages such as stability in the cash flows, insurance gain, tax benefits, and lowered performance variations. Lastly, the management synergies are associated with increased efficiency in the business processes of the combining firms. Basically, mergers and acquisitions result in a combination of different management strategies for better results in the decision-making process (Hahn & Kühnen 2013). For instance, the firms participating in a merger or acquisition gain from diverse, relevant, and competitive skills possessed by the management of the previously independent entities. These skills can be transferred to the newly created entity.
Growth and Performance
Growth is an important factor in the performance and sustainability matrix in any business environment. Mergers and acquisitions are responsible for inorganic growth, which is characterized by better and quicker expansion through merging different factors of production onto a single business platform. The inorganic growth expands the business capacity through an increased supply of outputs to satisfy the expanded customer demand base for the combining organizations (Bal et al. 2013). Moreover, merging partners have increased access to brands, facilities, technology, employees, and trademarks.
Diversification and Proactive Risk Management
Mergers and acquisitions are responsible for facilitating diversification of different products or business lines to guarantee an effective portfolio balance, thus, reduced risks. For instance, through a merger, the risks from the shareholders’ perspective, such as insolvency, are spread to the two merging businesses as compared to the single business strategy before the partnership. In the practical business environment, the probability of financial failure is higher for a single corporation than two merged organizations (Al-Zwyalif 2017). The combination of organizations, especially from the capital, production, and financial perspectives, has the effect of reducing the lender and operation risks since shares of the merging businesses are transformed into a single entity. Moreover, diversification of risks and opportunities results in increased possession of the required technical, managerial, and marketing expertise to catalyze growth and sustain performance. For instance, Ahmed and Ahmed (2014) note that vertical integration has the capacity of substantially reducing the productivity risks by managing the entire production matrix. On the other hand, horizontal mergers have the potential of reducing direct competition since competitor firms combine into a single organization, hence limiting direct or indirect uncertainties (Bal et al. 2013). In addition, the conglomerate merger model spreads the production lines to facilitate sustainable diversification and performance (Alewine & Stone 2013).
Tax Motivations
Mergers and acquisitions directly benefit the combining organizations by reducing the business tax bill even when they are done in stricter business environments. In most cases, largely profitable organizations merge with loss-making entities to help such struggling partners to benefit from reduced expenditures related to taxation. Moreover, the shareholders of the struggling organization would receive substantial tax benefits that can be pumped back into the resulting joint venture (Bal et al. 2013). This means that organizations that are making business threatening losses can merge with fully profitable and taxable firms to expand their tax benefit value. According to the international merger and acquisition law, the profitable and taxable firm in the partnership is expected to offset the credits and losses of the acquired firm using its future and current incomes (Alewine & Stone 2013). Thus, Rashid and Naeem (2017) conclude that an acquiring firm could directly benefit through the reduced tax bill, which results in increased performance since the funds that would have paid the taxes could be diverted to other uses in the merging firms. In addition, the assets of the merging firms could be moved among the shareholders without imposing a stamp duty (Bal et al. 2013). This means that the capital assets could be transferred on a no-loss-no-profit basis. At the same time, interest within the merging companies could be paid as a tax shield.
Improved Market Standing
Mergers and acquisitions are often integrated into the business environment to improve the financial, operational, and managerial strategies to increase the market share and assume industry leadership (Rashid & Naeem 2017). This means that contemplating mergers and acquisitions are driven by the desire to proactively protect the market from other competitors through concentrated market power. When properly executed, the combined organizations might be in a position to charge prices for products or services over a prolonged period of time without fear of losing the market due to dominance (Bal et al. 2013). For instance, the Chrysler-Benz merger resulted in increased market power characterized by higher prices for this brand and expanded market coverage. Through this merger, Benz and Chrysler’s brands have been able to eliminate internal competition between the firms and protect a dominant position.
Negative Impacts of Mergers and Acquisitions
When the takeovers or mergers are done without synergies, Al-Hroot (2016) and Arikan and Stulz (2016) concur that the management of the acquiring firm may suffer from managerial hubris. This is a condition characterized by overconfidence in evaluating the business targets. Due to the poor due diligence, the result of such an undertaking might lead to a negative correlation in performance sustainability (Rashid & Naeem 2017). While the ideal effect of hubris should be experienced at the individual level, poor due diligence and overconfidence in large acquiring firms might affect the managers who participated previously towards growing such organizations in their state before mergers (Arikan & Stulz 2016). Acquisitions and mergers are also associated with increased managerial rewards and compensations. For instance, managers of corporations that have distinct ownership and control are more likely to push for mergers with the intention of getting higher rewards and pay packages (Bal et al. 2013).
This behavior is common in organizations that peg employee rewards on the performance targets. In the short-term, the motivation for increased pay is destructive and might lead to failed mergers. For instance, excessive prioritization of personal gains by the management of merging firms would have negative impacts on the resulting entity (Ahmed & Ahmed 2014). When the intention for a merger or acquisition is based on prestige and power, the resulting business platform might be void of important synergies that sustain organizational performance. However, Hahn and Kühnen (2013) disagree that hubris has the potential of interfering with the true value of the merger or acquisition when the interests of the managers override organizational power. Al-Hroot (2016) concludes that the aspects of control, authority, and variations in management strategies between management teams of combining companies have a negligible effect on performance sustainability, especially in the short-term.
Theoretical Perspective
The free cash flow theory suggests that mergers and acquisitions result in improved cash flow in the new entity due to the amalgamation of resources and other factors of production for a stable operational matrix (Huh 2015). This means the mergers expand the cash flows that are available for lenders and suppliers after deduction of operational and other investment expenses in the fixed and working capital (Al-Hroot 2016). When the cash flow is available and disposable, managers tend to push for acquisitions or mergers for the acquiring firm to expand the market power.
Rationale for the Proposed Analysis
The past literature concentrates on the general performance improvement and incentives for mergers and acquisitions. For instance, the authors dwell on diversification, business environment, and improved capital structure as some of the impacts of merging organizations. Moreover, the studies have not focused on the Indian business environment. Thus, there is a need for further research on the actual impacts of mergers and acquisitions on the sustainability of the merging firms’ performance in relation to the Indian Aviation Industry. Thus, this report aims at filling this literature gap.
Research Approach
The research aimed at establishing the impacts of mergers and acquisitions on the sustainable performance of merging firms within the Indian Aviation Industry was carried through secondary data analysis. Specifically, data were collected from reliable secondary sources such as operations management journals, scientific reports, and relevant books. The analysis was concentrated on the Jet Airways-Air Sahara and Kingfisher Airlines-Air Deccan mergers. The results are discussed below.
Findings and Analysis
The findings indicated that the Indian aviation industry experienced liberalization in the 1990s, when many private airlines entered this market. For instance, Jet Airways, Air Sahara, Kingfisher Airlines, and Air Deccan entered the Indian aviation industry in the 1990s. Strategic mergers and acquisitions have occurred in the Indian aviation industry (Arikan & Stulz 2016). These strategic alliances have resulted in a long-term commitment to expansion and growth of the merging airlines over the years.
Merger between Kingfisher and Air Deccan Airlines
The merger between Kingfisher and Air Deccan was a game changer in the Indian aviation industry. Before the merger in 2006, Air Deccan was a market leader in low cost aviation services while Kingfisher concentrated on the ordinary airline services. The two airlines merged and changed the name to Kingfisher Aviation. The merger began when the owner of Kingfisher Airline bought a 26% stake in Air Deccan (Arikan & Stulz 2016). The combined entity expanded its fleet from 23 for Air Deccan and 29 for Kingfisher to 71 aircraft that cover more than 70 destinations with slightly more than 600 flights every day. The merger resulted in several positive synergies such as improved inventory control, engineering, maintenance, and overhaul of old technology. As a result, the cost of operations reduced by between 4% and 5%, which translated to a saving of Rs 300 million (Arikan & Stulz 2016).
Further, the Kingfisher Aviation was able to optimally and efficiently rationalize its destination coverage by adjusting the fare structure, thus, attracting more passengers. The merged entity also created a strong and reliable business model which expanded the domestic market base for the low cost section and international market through the Kingfisher Airline division. Financially, Kingfisher Airline was able to save on operational costs, thus increased profits in the short and long-term. The merger also eased the operational and logistical structure of the new entity since the two airlines share a maintenance contract, Airbus fleet, and similar engines (Arikan & Stulz 2016). In terms of financial performance, the merger between Air Deccan and Kingfisher from the year 2006 has resulted in improved profitability margin (see table 1). In order to establish the impacts of the merger on financial performance, the analysis was carried out two years before and after the merger.
Table 1. Financial performance of Kingfisher Airline before and after merger. (Source: Arikan & Stulz 2016).
The results of the financial performance of Kingfisher Airline before and after the merger are similar to that of Air Deccan, especially in terms of the trend. Apparently, the operating margin for Kingfisher Airline dropped to -26.5%. The gross operating margin also fell to -33.9. The same trend was observed in the return on capital deployed and net profit margin in the post-merger period. Kingfisher Airline’s EPS fell drastically due increase in the number of shareholders following a merger with Air Deccan. However, the after tax profit fell after the merger. The shareholder equity in Kingfisher Airline deteriorated in the post-merger period. In addition, the P/E ratio is an indication that the Kingfisher Airline stocks were undervalued before the merger as suggested by the sharp upward rise in share prices after the merger.
Air Sahara and Jet Airways Merger
Jet Airways began its operations in the Indian aviation industry more than two decades ago and is currently the market leader, in terms of industry share. The merger resulted in expansion of Jet Airways (62) and Air Sahara (26) fleets before the merger to 88 aircrafts after the creation of a new entity. Since the two airlines used similar fleets, the main synergy improved operation model, especially in the domestic market efficiencies (Arikan & Stulz 2016). The merged entity rationalized the operational cost aspect in running and maintaining the fleet. Due to almost perfect mix in the fleet type, the two companies were able to streamline the operational costs after the merger. The financial performance of Jet Airways was analyzed two years before and after the merger (see table 2).
Table 2. Financial performance of Jet Airways before and after merger. (Source: Arikan & Stulz 2016).
As displayed in table 2, Jet Airways had strong operating margins before the merger and it slowed down after the creation of a new entity. The gross profit margin was equally strong before the merger at 24%, but lowed to a negative value of -6.4%. The return on capital equally performed poorly. Before the merger, the return on capital employed was 31.6% and it fell to 4% after the creation of a new entity. Interestingly, the return on net worth of the airline also fell drastically after the merger. This means that the merger between Air Sahara and Jet Airways did not result in any substantial returns to the shareholders (Arikan & Stulz 2016).
Overall, the findings suggest that Jet Airways has managed to post positive operational margins after the merger while Kingfisher Airlines only recorded negative performance. This means that mergers and acquisitions have not substantially resulted in a sustainable performance in the tested cases.
Conclusion
Companies have adopted mergers and acquisitions to foster inorganic growth, especially when the combining firms operate in the same sector or industry. The motivating factors behind mergers and acquisitions include tax advantages, improved capital structure, expanded market coverage, and general operational efficiency. However, the findings from testing two cases of mergers in the Indian aviation industry suggest that they have positive and negative impacts on performance sustainability. In fact, the tested firms performed dismally after the merger than before. Therefore, there is a need for more research to establish the impacts of mergers and acquisitions on performance sustainability by incorporating many firms in different sectors. This will give conclusive results that could be representational of the actual scenario on the ground.
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