So of course, you wouldn't marry anyone you don't even know. And in fact there's plenty of stuff to consider in advance. And the first thing to consider is, to what degree acquirer and target are related and to what extent do they fit together? And to answer that question is definitely not an easy one. That's probably the most difficult one to answer in the whole merger process. Why is that? Well there are different dimensions of relatedness that we have to take into account. There are relatedness in terms of strategic characteristics like product portfolios. There's relatedness in terms of organizational issues such as managerial styles. So if the managerial styles of two firms just don't fit, then any kind of well meant merger may just not be succesful. Another dimension of relatedness is the external and the internal dimensions. So externally, we think about geographical markets. So do the geographical markets that we're active in match the ones that our merger partner is active in, or is it actually important that we enter in different markets? So geographical markets can be related or not. And internal aspects such as core competencies can be related or not. So do we have matching, do we have complementary core competencies or not? And finally and that's almost at the core issue of what relatedness actually is and what fit actually is, is there relatedness because there are similarities? Or is there relatedness because there are complementarities? So we're gonna talk about this in a few minutes. But, so what could be sources of synergies? Source of synergies could be, and we know that from the previous modules, source of synergies could be economies of scale quite simply. So if two firms merge, they have a higher output level. Higher output level means that we can usually operate, if there are economies of scale, we can operate at a lower unit cost. There could be economies of scope. By combining two different product portfolios, we may be able to leverage economies of scope. There may be increased market power. Quite simply, if two firms in the same industry merge, they become larger relative to the other firms in the industry, which makes them more powerful. So that gives them their own incentive to actually merge, to try and go together. And finally, we may simply diversify risk if two firms in a conglomerate merger merge. So that's something that can also increase the value of the joint firm by realizing synergies through diversification economies. So, what's important to note; however, is that the effects of relatedness and fit do not just fall from heaven, right? So you cannot, even if you've identified potentially large synergies, you cannot count on those being realized automatically. They depend on deliberate integration activities. In other words, even if synergies are high, you're gonna have to work for them. Now what are problems that we can face with relatedness and fit evaluation? Similarities can offer synergistic potentials. In other words, sometimes it's very good to be very similar to the one you're merging with, but so do complementarities. Sometimes firms merge, or want to merge for their unique differences that is going to make them, or that are going to make them more powerful as a result. So, when we think about some examples here, looking at these two dimensions, similarity and complementarity, and products and core competencies. For example, in a case of MINI and BMW, this made perfect sense, this merger, because they were operating in similar product markets, and so they had similar product markets. Looking at core competencies and similarity, the case of Safeway and Albertsons wanting to merge, on the one hand, they had similar product portfolios. But they were also very strongly sales-oriented, meaning that they had similar core competencies. And that's where they expected the benefits of synergies to come from. Firms having complementary product portfolios or products would be eBay and PayPal. So if you do a transaction on eBay and you have to pay for it, you can do this by using PayPal. So it was clear they were complementary in their products that they were offering. And finally, looking at complementary core competencies, HUMAN GENOME SCIENCES was a firm that was very good at early stage research. Whereas Glaxo Smith Kline was a large pharmaceutical giant that was very good at commercializing innovation. So the two had complementary core competencies that made them perfect matches in terms of a merger. So assuming now that we've identified these sources of synergies, we've identified relatedness by using either similarity or complementarity. How do we get to a purchase price? And what basically determines the synergy value and what determine the benefit that both the acquiring shareholders and the taken-over shareholders will get from a merger? Well so we start out with the intrinsic value. The intrinsic value of a firm is the net present value of expected future cash flows. Typically, the market value will be higher than the intrinsic value, because that market value includes a premium, or it includes possible premiums, for example, in anticipation of takeover offers. All right, so the market value is typically higher than the intrinsic value. The price that's paid by the buyer is the purchase price, of course. And so, that's often even higher than the market value. Typically there's a markup per share. And of course this deal only ever makes sense if the synergy value that is going to be realized in the end is higher than the purchase price. So in other words, the synergies to be realized following a merger have to be larger than what the premium is paid by the shareholders of the acquiring firm. So who benefits and who benefits how much? Well the value to the acquirer's shareholder is simply the difference between the synergy value and the purchase price, right? So that's what the acquiring share holders get extra on top of the purchase price. On the other hand, the value to the target shareholders is the difference between the intrinsic value and the purchase price. So that's what the target shareholders expect to get from a takeover or from a merger. So let's summarize all of this in a short in-video quiz, and then we'll wrap up. Okay, so now you know each other, and you're absolutely certain that your chosen company is the right one. It's the perfect match for your company, and you wanna take the next steps. But wait, don't forget to consider the workings of merger control which we'll deal with in the next video. Stay tuned.