Question

Question:17. During the dot-com era, mergers among some brokerage houses resulted in the acquiring firm paying a premium on the order of $100 for each of the acquired firm's customers. Is there a business rationale for such a strategy? Do you think these circumstances are met in the brokerage business? Explain.

Short answer

Answer:

The feature at the time of the acquisition is that some brokerage businesses have a two-way network and would be able to take advantage of theexternalities to improve profits, leading to the acquirer paying a premium.

Step-by-step solution

Externalities

During the era of dot-com companies, it caused a great expansion of networks and interconnections between users creating positive externalities calledDirect Network Externalities. In this condition, a network will be more valuable as it can integrate more users to its network. A network that connects two users will be more valuable than one that only connects one user, and so on.

Circumstances in Brokerage Business

The externality principle will be satisfied in the following situations: A two-way network connecting users offers n (n-l) potential connection services, and if more users are added, the others will also have access to these services since the new user increases the network's n potential connection services by 2. With the anticipation that the value these businesses would generate would be quite large, many organizations in this age were willing to pay high commissions, sometimes even on the order of for each customer of the acquired firm.

However, the fact that some brokerage firms have a two-way network and could take advantage of these externalities to increase profits, resulting in the acquirer paying a premium is another fact at the time of the acquisition. When making these decisions, we were taking into account financial variables. A state-of-the-art powerful merger of some companies facilitates connections between one actor (broker) and two other actors (changers) who are not connected to themselves.

The idea of being able to create a network of structured brokers creates potential benefits justifying.