Consolidation connotes the process of gathering and collecting something. The word is often used in economics to describe a rise in production and volume, and hence value, which arises from increased efficiency and reduced costs.
In finance, it can refer to consolidating debt instruments by repaying them with other securities or it can refer to a take over of smaller businesses as a way of increasing scale. In financial fintech, consolidation strategies are related to mergers or takeovers that happen when one company takes over another for strategic reasons such as improvement in profitability.
Consolidation strategies, generally, are aimed at providing solutions that enable businesses carve out a niche in the industry they operate or enable them realize their full potential.
Consolidation strategies for small and new businesses
With the ever increasing competition businesses have to deal with, consolidation strategies are a very important strategy for keeping business operations sustainable. Often, it is common to see companies merging with each other to improve their services and increase their size. This will enable them access some of the advantages of having a larger organization while avoiding some of the disadvantages. For example, it is easier for larger organizations to raise more capital through stock sales or through venture capital firms, but they are also more vulnerable when there is a downturn in sales or when they have to deal with unprofitable businesses. This makes it easy for startups to attain an advantage over these established players even though at times they lack experience in some aspects of business operations.
Consolidation strategies that are pursued by new firms may be related to acquisition. For example, a company that operates in the financial services or brokerage services may come up with a similar idea and hence be interested in acquiring another company to acquire their technology. This is a course of action that they will choose if they think that a merger can help them improve their services especially with regards to transactions and customer targeting.
A common strategy now employed by firms is the use of crowdfunding as an alternative method for raising funds. In this instance, the companies retain their own brand as this allows them stay independent as opposed to using corporate finance from banks. They can also use this method to raise funds and keep their own brand.
Another common practice is to acquire smaller companies to gain access to new technologies, acquiring customer bases and even new employees.
This approach is often taken by companies that are deep-pocketed such as big banks and trading firms. Banks will often acquire technology companies that offer financial service applications for mobile devices or offer payment processing services. However, there is a chance that the customer base of the acquired company will not increase much because the smaller organizations are reluctant to share technology or expertise with other startups in fear that they can lose it when acquired later on.
Mergers are also employed by companies that want to increase their size, improve their operational efficiency and reduce risks. Mergers can be employed by both young and established companies. For example, insurance companies will buy banking assets from huge banks, while banks may also merge with smaller banks to improve operations. This is an approach that is useful for established players but it can be a strategy with less value for new players in the financial services sector since they do not have the advantage of having a large customer base or capital. Large organizations will even use mergers as a way of acquiring technology without having to acquire entire startups and paying them big money.
What are the types of Consolidation Strategies?
There are two different types of consolidation strategies: horizontal and vertical. Horizontal deals with combining like items (assets), while vertical deals with combining like companies (mergers). When either type takes place, consolidating typically involves taking assets from one company and transferring them over to another company. This is usually done in order to simplify the debt situation and/or to create a larger company.
For horizontal consolidation, assets are taken from one company and combined with another company’s. Both companies typically exist in the same industry, and typically one is a smaller entity than the other. By combining these two entities into one, you then have a larger single entity that will be stronger than either of the original entities were individually.
Horizontal consolidation can be done in multiple different ways: (1) by purchasing assets from another company; (2) by purchasing shares of stock; (3) or by purchasing bonds or notes issued by another corporation or government agency.
In any case, there are advantages and disadvantages to horizontal consolidation. One advantage of horizontal consolidation is that it gives a company a stronger position within the industry. As a single entity, a company can be more competitive against other companies within its industry if it has more resources under its control. A second advantage is that by consolidating two entities together, redundant costs and excess liabilities from both companies can be eliminated. This makes sense if both companies are essentially operating at break-even margins.
Another benefit of horizontal consolidation is that it can help reduce redundant costs or excess liabilities between both companies.
The main downside of horizontal consolidation is that it may put a company into too much debt if proper due diligence is not undertaken before embarking on such consolidation process. When this happens, the business no longer operates at break-even or even provides excess cash flow for shareholders. Instead, it just covers all of its operating costs with its own revenue and pays off all of its debts with its own cash flow.
Consolidation strategies are often employed by companies when it is analytically determined they are not able to compete optimally in an open market where competition between players is high. It can also be useful for big companies since it helps them make improvements whereas small companies cannot make changes as fast as big businesses due to lack of funds and resources.