How Geographic Location and Agglomeration Externalities Drive Post-Acquisition Decisions

When a company acquires another, one of the critical challenges managers face is deciding how to integrate the new firm's assets with their existing ones. This decision to keep, sell, or close a newly acquired establishment is influenced by internal motivations, such as mitigating competition and reducing production redundancy, as well as external factors like economic agglomeration externalities. At the Eighth Annual Mergers and Acquisitions Research Conference held at Bayes Business School on June 18th, we presented our study highlighting the importance of geographic location and agglomeration externalities in shaping the boundaries of the newly combined firm.

Our research reveals that the role of geographic proximity in the decision-making process varies depending on the type of firm being acquired. For instance, when acquiring a competitor, establishments in the same city as one of the acquirer's existing establishments are more likely to be closed and less likely to be sold or kept. This trend is driven by the need to reduce production redundancies and maintain local competition.

In contrast, when the acquired firm is a customer or supplier, the newly acquired establishment is more likely to be kept if it's located in the same city as the acquirer's existing establishment. This highlights the strategic advantage of having geographically proximate inputs for production.

The Importance of Geography in Post-Merger Restructuring

Our findings underscore the significance of geography in the post-merger restructuring process, shedding light on how local agglomeration economies are established and reinforced. Economic agglomeration, which refers to the benefits of shared resources and knowledge spillovers, dates back to the early 20th century[1]. When firms can internalize these benefits post-acquisition, it makes sense to retain local establishments regardless of whether the acquired firm is a competitor, customer, or supplier.

Using proxies to capture three dimensions of agglomeration—input sharing, knowledge spillover, and labor pooling—we found consistent results supporting this notion.

Input Sharing

Input sharing refers to the benefits that arise from economies of scale in shipping, distribution, and localized production of inputs. When a firm acquires another company, the newly combined entity can achieve significant cost savings by consolidating and optimizing their supply chain and logistics operations. For example, if both firms use similar raw materials or components, centralizing their procurement and storage can reduce transportation. When the benefits of input sharing are high, newly acquired establishments located in the same city as an existing establishment are more likely to be kept. This strategic retention maximizes the efficiency and cost-effectiveness of the firm's supply chain.

Knowledge Spillovers

Knowledge spillovers refer to the exchange and diffusion of ideas, technologies, and best practices between firms. When two companies that utilize similar technologies or operate in related industries merge, their geographic proximity can foster an environment of innovation and continuous improvement. Employees from both firms can collaborate more easily, share expertise, and develop new solutions to common challenges. When the benefits of knowledge spillovers are high, the newly acquired establishments located in the same city as an existing establishment are more likely to be kept. This strategic decision helps the firm capitalize on the synergies and collaborative opportunities that geographic proximity offers.

Labor Pooling

Labor pooling refers to the benefits of having access to a large, skilled labor force within a specific geographic area. When a firm acquires another company, having both establishments in the same city can create a robust labor market that attracts and retains talent. This is particularly advantageous in industries that require specialized skills and expertise. By maintaining a presence in a location with a rich labor pool, firms can benefit from a steady supply of qualified workers, reducing recruitment costs and minimizing the risk of skill shortages. When the benefits of labor pooling are high, newly acquired establishments located in the same city as an existing establishment are more likely to be kept. This strategic retention leverages the local talent pool to sustain and enhance the firm's operational capabilities.

Productivity Gains from Agglomeration Externalities

If agglomeration externalities are effectively internalized, the retained establishments should show significant productivity gains. Our research confirms this, indicating that establishments benefiting from agglomeration externalities exhibit substantial increases in productivity, regardless of the type of firm being acquired.

Our study provides valuable insights into how firms decide the fate of newly acquired establishments based on geographic proximity and potential agglomeration benefits. Managers are evidently aware of these benefits and actively seek to exploit them, reinforcing and expanding existing agglomeration economies. The decision-making process post-acquisition is highly sensitive to these potential benefits, ensuring that establishments that can leverage agglomeration externalities are retained, thereby strengthening local economies and enhancing firm productivity.

In conclusion, geography and agglomeration externalities play a crucial role in post-acquisition decisions. By understanding and leveraging these factors, firms can make strategic decisions that not only integrate the new assets effectively but also reinforce and expand the economic benefits of agglomeration, leading to stronger, more productive enterprises.

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[1] Marshall (1920) emphasized that the costs of moving goods, people and ideas each provided firms located with the geographic area potential gains from industrial agglomeration.

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By Samuel Piotrowski (NHH Norwegian School of Economics), Jarrad Harford (University of Washington), and Yiming Qian (University of Connecticut)

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