When you are traveling and there are 8 people and only 5 people can fit in one car than you have to hire two cars instead of one car so that 4 persons can sit in each car, this act of splitting into two groups so that you can travel comfortably is similar to demerger done by the companies. In case of mergers, two companies merge into each other so as to form one company but some companies tend to do opposite that is they decide to split one company into two companies and this act of company splitting into two companies is called demerger. In order to understand more about demerger, one should look at the advantages and disadvantages of demerger –
Advantages of Demerger
Smooth Operations
The first and foremost advantage of demerger is that it results in smooth operations because when company is big than it is not possible to take area of all areas but when company is split into 2 or 3 companies then each company will have separate top management which ensures that all areas of operations of the company run smoothly. Hence for example, if in a school there are 100 students in one class than it is very difficult to manage all students but if those 100 students are divided into 4 classes of 25 students each than it is very easy to manage all the students same is the case with the company doing demerging.
Helpful in Fixing Accountability
Another benefit is that it helps in fixing the accountability of the top management because when company is big and there are many departments then each department and top management blame each other for the failure but when company is demerged than each company’s top management will be separately accountable and responsible for any failure or loss happening in the company. In simple words if there are 4 sections of 100 students having 25 students each and if students of 3 sections do well but students of 1 section perform poorly than it is easy to fix accountability of class teacher of that section rather than finding fault if there is only one class of 100 students.
Unlocking of Value
It results in the unlocking of the value of the company as a whole because when demerger happens separate companies achieve efficiency due to the specialization of operations which results in greater overall profits for the group of companies as a whole.
Disadvantages of Demerger
Reduction in Economics of Scale
The biggest disadvantage of demerger is that company loses economies of scale which it was enjoying due to the large size of the company as when the company is of a big size it can have good economies of scale which is not possible in case of a company getting split up into small companies. Hence for example if 3 friends live in one flat together and if all three friends decide to live alone in 3 different flats than it will be more expensive as compared to all friends living in one flat together.
Clash of Interests
Another limitation of demerger is that there will be clash of interest between the top management of companies which are demerged because when there is only one company then there is no question of clash of egos as there is only one top management but when company gets demerged into 2 or 3 companies than clash of egos or interests are bound to happen due to presence of more than one top management.
Employees Problem
When company decides to demerge than some employees have to go to newly formed company while some employees have to keep working in the same company, if employees are given option to choose between the companies than it’s all right but if employees are asked to join the new company without their consent then it will lead to employee dissatisfaction which in turn will lead them either leaving the company or working without motivation which in the long term can be very harmful to the company.
As one can see from the pros and cons of demerger that while it has many positives but at the same time it has shortcomings too and that is the reason why any company thinking of adopting demerger strategy should carefully read above points and then take the decision accordingly.