Discuss the likely problems for Sainsbury’s and Morrisons if the suggested merger between them goes ahead

Edexcel A-Level Economics Paper 1 June 2017 Extract

Discuss the likely problems for Sainsbury’s and Morrisons if the suggested merger between them goes ahead. Refer to Figure 1, Extract C and your own knowledge in your answer. (25 marks)

Horizontal integration is when two firms at the same stage of production in the same industry join together.

One issue could be a lack of synergy leading to diseconomies of scale. Extract C refers to the difficulty of co-ordinating hundreds of thousands of workers, implying that there may be issues in communication. This could cause long run average costs to rise beyond the minimum efficient scale, representing a fall in productive efficiency. According to Forbes, 83% of mergers fail in this manner, where synergies are often imagined but fail to materialise in practice.

However, to evaluate this, Société Générale does believe some economies of scale could be generated — perhaps financial economies, for example, allowing the merged firm to access credit at lower interest rates. Thus, while there will be some communication difficulties, these may be outweighed by the financial economies of scale, which could lower costs and enable the firm to pass on lower prices to compete in the current price war.

A second problem may be excessive risk arising from over-exposure to the supermarket industry. Food prices have fallen by 1.7% over the last 2 years as Aldi and Lidl continue to gain market share by undercutting others; Tesco has had to issue profit warnings. The resulting merged firm is essentially putting 'all of its eggs in one basket' — in this case the supermarket industry where profits are falling. Thus, this can be viewed as a risky move, since any further deterioration in market trends could mean losses for the firm, with few options to cross-subsidise these losses since it is so heavily focused on the supermarket industry.

However, in evaluation, the merger may actually enable the survival of Sainsbury's and Morrisons in the industry. The merged firm would control 27.4% of the industry, enabling it to increase monopsony power and be better prepared for a continuation of the price war with larger combined cash reserves. On its own, Morrisons may have struggled in the longer-term. Thus, moreover, the supermarket industry as a whole has fairly constant demand, meaning it is not as risky to be involved in the long term as other markets such as oil.

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