In July 2017 the German retailer Metro Group demerged into two independent companies.

Its wholesale and food division became New Metro and a separate consumer electronics
business, CECONOMY, was formed.

A demerger occurs when a firm splits itself into two or more separate parts in order to create
two or more firms. In this case, Metro Group, a German retailer demerged into two completely
different companies GSK is demerging is ‘consumer health’ business from its ‘pharmaceuticals
and vaccine’ business. Demerging means that each of the core businesses is likely to reduce in
scale of output. This could enable the business to move back along the long-run average cost
curve (from SRAC1 at point A to SRAC2 at point B) towards the minimum efficient scale of
production, thereby reducing cost per unit from C1 to C2.

This introduction sets the

scene by defining the key
term and links the concept
to relevant economic
theory. That is all that is
needed here.

Diagram showing demerger:

The answer requires a diagram. To

be awarded credit the text must
refer to the diagram, with
appropriate chains of reasoning
explaining the diagram. The best
answers fully integrate diagrams
into the analysis.

A potential benefit to the firm of a demerger is that it allows the two newly formed businesses to
focus on separate customer groups, which could lead to efficiency gains and thus increased
profit per unit. Demerging has the advantage of allowing the firm more specialisation within each
separate market, which may lead to improvements in efficiency and customer service.
Improvements in efficiency, such as speeding up decision-making in a smaller firm, could lower
the costs per unit, thereby enabling the firm to potentially increase profit per unit. This is
perhaps the greatest potential benefit that could arise from demerging. Economic theory
suggests that management of each separate business can then deliver higher profits and
growth by concentrating its energies on getting to know and exploit a limited range of markets.
Evidence also suggests that being the market leader in terms of sales tends to be relatively
more profitable than being the number three or four in the market, for example. Companies
therefore divest themselves of (i.e. sell off) parts that do not fit in with their core activities.
Furthermore, increasing profits per unit may give the two separate businesses greater
opportunities to invest in new and innovative products for their separate markets, thereby further
increasing the potential profitability of the separated companies. In addition, focusing on
separate markets may lead to an increase in market share, thus increasing price-setting power
in the future.

However, the potential benefits to the firm of higher growth and higher profits will depend on
the success of the demerger. For instance, the expected cost savings from demerging may not
occur or might be lower than anticipated. There is also the possibility that potential staff
redundancies following the demerger could reduce staff morale, which could reduce
productivity, thereby increasing costs per unit in the short run. Furthermore, if the workforce is
unionised, the announcement to demerge may lead to industrial unrest in the form of strikes,
which could impact on the costs and revenues of the business. Finally, there is also the risk
that the business may lose some synergies by demerging, for instance, the two smaller firms
that result may have reduced buying power for the raw materials needed to make consumer
health products, vaccines and pharmaceuticals.

Potential benefits to the consumers of a demerger could be Again, two well-developed

the potential improvements in customer service (in terms of
choice and quality) and the potential for lower prices for paragraphs that stay focused
products following the removal of diseconomies of scale on the question.
from the organisation. Diseconomies of scale include the
communication and coordination problems that large firms face. By demerging into two separate
businesses, the firms should be able to respond more quickly to changes in customer demands
as there are fewer layers of management within the newly separated firms. This should speed
up decision-making and ordering processes within the two separate firms. Furthermore,
efficiency gains in the form of lower costs per unit may be passed on to customers in the form of
lower prices, thereby increasing consumer surplus. In addition, if the newly demerged firms
reinvest profit in product development, consumers could benefit from better and more innovate
products. For instance, the newly demerged ‘consumer health’ business may develop a new
range of medications aimed at common illnesses, thereby increasing both choice and quality for
the customer.

However, the extent to which consumers benefit from the demerger will depend on whether the
newly demerged firms choose to pass on efficiency gains in the form of lower prices. The firm
may instead choose to distribute increased profit to shareholders via increased dividend
payments. Similarly, customer service may not increase in the newly demerged business,
especially if the firm has made redundancies and the remaining staff are demotivated.
Furthermore, demerging has the potential of removing potential synergies that customers have
enjoyed. Customers (e.g. LloydsPharmacy) will now need to order non-prescription ‘consumer
health products’ from one firm and ‘prescription medication and vaccines’ from another. This
could increase the administrative burden for customers and the amount of time it takes to order
products, which could lead to increased customer dissatisfaction.

Whether the firm benefits from the demerger will depend on the overall effect on efficiency. If
efficiency gains can be realised, the firm will benefit. The firm will lose out in the long-run if the
demerger leads to more inefficiency and results in the demerged firms being run less well than
when they were a single firm.

Consumers may benefit or lose out following a demerger. They will benefit if the demerged
firms become more efficient, cut costs and offer lower prices. They could also gain if the
demerged firms invest in new and innovative products. Consumers will lose out if the
demerged firms become more focused on increasing profit in their businesses through raising
prices or reducing their product ranges.

On balance, it is more likely that the lower costs resulting from a demerger will benefit both the
firm and the consumers. However, the extent to which these benefits are achieved will also
depend on the reaction of rival firms in the market to the demerger.

A clear conclusion that answers

the question and justifies the
decision.

The candidate has further

strengthened the conclusion by
adding what this conclusion
depends on, and ends with the
most important reasons why
they have reached this
conclusion.