UK Electricity Industry Analysis

The term acquisition refers to a situation where one company purchases the shares in other. This can be through cash or by issuing its shares or a loan stock in exchange for the shares. This method of business combination is also referred to as the “purchase method”. In an industry, there can be scarce resources that a firm may exploit but which it cannot single-handedly. Acquisition then becomes of the essence for the company to capture a wide market and make use of available resources. In the UK electricity industry, there are many government regulations, especially the EU environmental legislation. This stipulates that companies should be wary of carbon emissions to the environment. This is likely to lock many of them that may not have complied with this legislation by 2015.

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In acquisition, companies do not combine. The companies remain independent separate legal entities. However, there may be changes in control. A company can acquire effective control of another company by owning not less than 25% of the voting power in that company. In the UK electricity industry, acquisitions fall into three categories. These are the horizontal structures, vertical structures, and mixed structures.

A merger is simply a combination of two or more firms to form a single firm. In the UK electricity industry, many companies have merged in the recent past. An example is a merger between RWE and VIEW in April 2000. The merger resulted in the two companies almost dominating the market with duopolistic effects. Now the two companies have a market share of 70% of the electricity industry in Germany. It is a business combination where the shareholders of the combining enterprise combine control over, the whole, or effectively the whole of their net assets and operations to achieve a continuing mutual sharing in the risks and benefits attached to the combined entity such that neither party is the acquirer.

The UK electricity industry is threatened by new entrants to the industry. The number of electricity-generating firms is around 15. In 1990, there were about three of them. This has the risk of the price of electricity declining due to competition. To combat this, two or more companies may unite their interest (merge) with the sole aim of increasing their market power (share). By doing this, more efforts can then be directed towards the customer rather than fighting the competitor. An example was RWE and VIEW that merged and improved their market share to 70%.

The opportunities and benefits of acquisition

The acquisitions arising in the electricity industry in the UK have given the acquirers a competitive edge over the other power-producing companies. When Louisville Gas and Electric (LG&E) acquired UK energy in 1998, the demand for its electricity rose suddenly to more than 350,000 customers. The electricity market in the UK is much liberalized. The price elasticity in the electricity industry triggers a more than proportionate demand, Because acquisitions lead to a reduction in operating costs, costs of equipment, reduced labor costs, etc, LG& E was able to reduce the price of electricity and be able to operate profitably. The result was an increase in demand hence a high sales turnover of electricity. For instance, after acquiring the UK energy was able to serve more than 300,000 customers with natural gas. Therefore, an acquisition offers the enterprises an opportunity to capitalize on the responsiveness of their customers to prices changes, which are a direct consequence of acquisitions (and mergers).

Acquisitions offer the companies a good opportunity to make use of technology in the market. The electricity industry requires technological techniques in its manufacture. 3.7% of the UK energy is produced from nuclear and about 5% is because of renewable energy. An electricity firm can acquire another to take advantage of its diversified technology in the production of electricity.

Another benefit arising from acquisitions is that the combined entities would have a stronger market power/ share. More investors in the company, which shall be the Linchpin for the growth of the company. Internal growth is a slow process of growth. Internal growth may deplete a company’s resources and even affect its liquidity position; owing to the massive resources that would be required. If an electricity company intends to place reliance on internal growth as opposed to external like acquisitions, chances are that those companies, which have embraced acquisitions as a form of growth, might overtake it. Internal growth is also barred from becoming a success due to an agency of conflict inherent in the management. Management may undertake projects, which are only profitable in the short – run to benefit from them only during their period in office. A single firm may also not be having a well competent staff to push through the growth process. However, acquisitions.

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Inject new blood of management into the team that would steer the growth of the group company. Together with other related benefits such as reduced operating costs and other economies of scale associated with acquisitions, the process of growth is enhanced compared to internal growth.

Conclusion

Mergers and acquisitions have resulted in economies of scale and synergetic effects for the UK electricity companies. Increased market share, greater performance in the stock market, and customer satisfaction are just but some of the benefits of such combinations. However, challenges are also associated with mergers and acquisitions in the UK electricity industry. For instance, when RWE merged with VIEW in April 2000 the benefit was the domination of the market and other synergetic effects like waste management. However, the merger led to more than 3000 jobs being lost. The firms should also focus on the importance of ethical and cultural fits between them as this may make the acquisition/merger successful or a complete failure.

References

  1. Department of Trade and Industry, Government of UK.
  2. Oliveira, Gorini R and Tolmasquim M.T (2004): ‘Regulatory Performance Analysis Case Study: Britain’s Electricity Industry’, Energy Policy, Vol 32, No 11, pp 1261-76
  3. Navroz D. and Singh Daljit (2005) ‘Of Rocks and Hard Places: A Critical Overview of Recent Global Experience with Electricity Restructuring’, Economic and Political Weekly, Vol XL No 50, 10-16,
  4. Ernst & Young Report on Electricity Market to the Department of Trade and Industry, UK.
  5. Newbery, David M and Pollitt M.G. (1997): ‘The Restructuring and Privatization of the UK Electricity Supply-Was it Worth It?’, Public Policy for the Private Sector, No 124, World Bank.
  6. Stephen T. (2005) ‘British Experience of Electricity Liberalization: A Model for India? Economic and Political Weekly, Vol XL No 50, 2005.
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