A perfectly free market economy and the cycle of buyouts is one that every capitalist nation experiences. There’s no saying which is good and which is bad; every sector in every economy goes through the same cycle. While critics have argued that free markets have more economic boons, in India, liberalisation and buyout proved more profitable. Especially in the tech, auto and banking sectors.
Why is that? Let’s understand it in detail.
What are free markets?
In a free market economy, the law of supply and demand regulates production and labour. Companies sell goods and services at the highest price consumers are willing to pay, while workers earn the highest wages companies are willing to pay for their services. Sounds good so far?
Take mobile phones for example. The company Xiaomi introduces phones with new features every 6 months. This means that if you bought a Mi phone 3 months after it was launched, in another 3 months, some of its features will be obsolete. Since people prefer to buy the latest phones on the market packed with the best specs, its price will be the highest on Day 1. Thus high demand -> high price. This is known as Skimming strategy. After a couple of weeks, as newer models enter the market, the demand for the older version will reduce. Thus reducing its price; low demand -> low price. Now there are 10 companies in the market selling mobile phones with similar features. This means that the buyer has the option of weighing the specs and price of each company’s phone and deciding which to buy. In lieu of such competition, and in order to increase sales, Xiaomi may either raise the quality of its phones or further reduce their price plus.
This is the simple law of free market; wherein the price of a product is determined by its demand and supply; which in turn are influenced by competition and quality. Free markets are best preferred in the tech or auto industry because a) the world runs on technology and it must be made reasonably accessible and b) even a 5% reduction in the price of Rs 50,000 gadget is very valuable.
What are buyouts?
A buyout is the purchase of a company’s shares in which the acquiring party gains the controlling interest of the targeted firm. Let’s take the example of the Walmart-Flipkart deal. Walmart bought 77% stake in Flipkart, which was a loss-making company. Why? A buyout may occur because the purchaser believes it will receive financial and strategic benefits, such as higher revenues, easier entry into new markets, less competition or improved operational efficiency. In the case of Walmart, it was expecting access to the Indian market – one of the world’s fastest-growing markets.
Buyouts may also be profitable to the acquired company because a) acquiring firms have more resources to invest and b) there’s a general belief that acquisitions bring in more efficiency and this feeling can lead to increased sales. Plus with the 23% stake left with Flipkart, that much percent of the profits will now come to India; which is great because the company was any way making losses.
How are buyouts and free markets related?
As soon as news for the buyout came, Walmart’s shares fell by over 4%. This is because analysts realise that a loss-making company does not make profits as soon as it’s taken over. “As Flipkart is expected to generate meaningful losses for at least the next few years, this is clearly an investment for the future,” Moody’s analyst Charlie O’Shea said.
However, Walmart is now planning to trade Flipkart’s shares on the market. Selling stake to the public is the way private firms enter the free market. Depending on the financial reports of the company, merger and acquisitions and management, the demand for the share will either increase or decrease. And as the law for free markets goes, the share price will depend on demand and supply.
Thus most buyout companies that trade of the stock market will be a part of the free market cycle. Moreover, their products and services, like phones, online shopping etc, are all subject to competition, quality, and bandwagon. Thus their prices will keep fluctuating in the free market.