Business Expansion Through Acquisition

My objective is to better understand how a business should expand through acquisition. In a differentiated market where firms first choose quality and then compete in prices, the idea is to analyze acquisition as an expansion strategy. The specific questions I consider are the following: (a) is it better to acquire a direct or an indirect competitor? (b) how are the quality levels affected by acquisition and does it matter whether the path to increase quality is fixed costs or costs that depend on the volume of sales? (c) how are profits affected by acquisition? (d) how are prices affected by acquisition? and (e) what are the welfare effects of acquisition? To study these questions, I employ a spatial model in which each attractive location in the market is occupied by a business. The analysis shows that a firm enjoys superior profitability by acquiring a direct competitor. This obtains because independent of quality, the ability to coordinate prices with the acquisition of a direct competitor is strong: this reduces the intensity of price competition. Second, the model shows that the synergy created by direct mergers is inversely related to the cost of building quality when higher quality comes from fixed investments and is unaffected by the cost of quality when the costs depend on the volume of sales. Third, the model shows that post-acquisition, the merged firm implements reductions in quality when higher quality comes from fixed investments but chooses the same quality when higher quality is delivered by higher variable costs. Competitors respond by increasing quality in the first case and by leaving quality unchanged in the second case. In addition, when higher quality comes from fixed investment, direct acquisitions create a market outcome where price and quality are negatively correlated. Finally, the model shows that the effect of acquisition on total welfare is ambiguous in the case of fixed investment; however, it is unambiguously lower when higher quality comes from higher variable costs.