Edexcel A-Level Economics · Revision notes

3.1.3 Demergers

A demerger is the opposite of a merger: a single firm splits into two or more separate businesses. The previous topic covered why firms grow; this one covers why some decide they have grown in the wrong way, and what happens when they split.

What a demerger is

In a demerger, part of a company is separated off and becomes an independent business with its own management and, usually, its own shares. Existing shareholders typically receive shares in the new company, so they own both businesses after the split rather than one combined business.

Real examples:

• GSK separated its consumer healthcare business, which became Haleon, in 2022, leaving GSK to focus on pharmaceuticals and vaccines.
• Kellogg split in 2023 into Kellanova, focused on snacks, and WK Kellogg Co, focused on North American breakfast cereals.

In both cases, businesses with different growth prospects and different needs were run more effectively as separate companies.

Reasons for demergers

Lack of synergies Many mergers are justified by the promise that the combined firm will be worth more than the parts. If those synergies never appear, there is no reason for the businesses to stay together.

Diseconomies of scale As a firm grows, it can become harder to manage. Communication slows, coordination becomes more difficult and decisions take longer. Splitting the firm can restore control and responsiveness.

Focus on core activities Managers of a conglomerate must divide their attention between unrelated businesses. A demerger allows each business to focus on its own market, strategy and customers.

Unlocking value Investors sometimes value a conglomerate at less than its parts would be worth separately, because a diverse business is harder to understand and value. Separating the parts can raise the combined value of the shares.

Different investment needs A fast-growing business may need heavy investment while a mature business generates steady cash. Inside one firm, the two compete for the same funds. Separately, each can raise finance suited to its own needs.

Raising finance A firm may demerge part of the business to raise funds, reduce debt, or concentrate resources on its strongest activities.

Regulatory pressure Competition authorities may require a firm to separate parts of its business if their combination reduces competition.

Impact of demergers

On businesses

• Greater focus and clearer accountability for each management team.
• Possible loss of economies of scale, such as shared purchasing, marketing or administration.
• One-off costs of the split itself: legal, advisory and setting up separate systems.
• Each new business may be more vulnerable on its own, with a narrower range of products.

On workers

• Some jobs may be lost where functions are duplicated or no longer needed, while new head office roles may be created.
• Workers in a more focused business may benefit from clearer direction and better motivation.
• Terms and conditions can change, and there may be uncertainty during the transition.

On consumers

• More focused firms may respond better to customers, improving quality and innovation.
• If economies of scale are lost, costs may rise and be passed on as higher prices.
• A demerger can increase competition if the separated businesses compete with each other, potentially lowering prices.

Evaluation: The overall effect depends on whether the gains from focus and flexibility outweigh the loss of scale economies and the costs of separating.

Key terms

Common mistakes

• Treating a demerger as failure. It can be a deliberate strategy to unlock value or sharpen focus.
• Ignoring the costs of splitting. Separating systems, contracts and management is expensive.
• Assuming all stakeholders gain or lose together. The impact on shareholders, workers and consumers can differ.
• Forgetting lost economies of scale. Gains from focus must be weighed against higher costs.

How this has been examined

In the Edexcel papers indexed on this site, this topic has appeared once:

• 1-mark multiple choice — asked once (2019)

Where this goes next

Demergers reverse the growth covered in 3.1.2 Business growth, and they are often motivated by the diseconomies set out in 3.3.3 Economies and diseconomies of scale. Different types of firm are described in 3.1.1 Sizes and types of firms, and the objectives a newly separated firm might pursue are in 3.2.1 Business objectives.