Will the drawbacks of size outweigh the advantages of synergies in mega-mergers? Concentration into a few specialities is the key to success, says Robert Heller.
As corporations become increasingly swollen through larger and larger mergers and acquisitions (M&As), up-and-coming managers will find that they have to make the best of this inheritance.
Pharmaceutical managers will have one of the fattest bequests - $100 billion of acquisitions in the past decade, alone. And, if history is any guide, they will also inherit fat problems. Yet, the aggrandising magnates at key pharmaceutical companies such as SmithKline Beecham, Glaxo and Novartis would argue that history is bunk and that, this time round, the unstoppable M&A machine has been driven not by diversification but by strategic focus. The same argument could be applied not just to drugs but across the financial and industrial board.
It follows then that if strategic focus is the driving factor in modern acquisitions, the resultant mega-group will be off to a flying start because it combines like with like, rather than being hampered with the management of unfamiliar businesses. And, in the modern scenario, it is better to merge or acquire than stand pat. As global and regional markets coalesce round a few dominant super-players, it is argued, unless you achieve dominance, meaning first or second place, you will be crushed by the occupants of those top positions - or so the reasoning goes.
M&As enable you to combine two pieces of management magic: scale and focus. There's nothing new in this idea. It has long been clear that most markets support only three profitable players: number one, number two and one specialist. But, in pursuing the modern merger or acquisition, lessons can be drawn from looking at the best and worst US acquisitions of the 1980s. The bad buyers acquired entire companies larger than their own. The good guys typically bought smaller businesses, mostly parts of other groups. If they purchased a whole corporation, they swiftly sold everything save the piece or pieces needed for their strategic jigsaw. The winners thus demonstrated clear-cut strategic purpose, the losers fuzzy thinking.
This lack of clarity explains why most failed, fatally, to seize full management control of their acquisitions. Doing so was harder, in any event, because of the far greater relative size of these acquired companies.
This raises a question mark over the present surge of multi-billion dollar deals. The managements will have to cope with much-bloated corpocracies.
So, will the drawbacks of size outweigh the synergies?
Perhaps. Looking into the pharmaceutical buying spree, consultants A T Kearney have found that acquisitive drug companies mostly produced poorer results than non-acquirers. The latter trailed between 1967 and 1992 but then forged upwards as the big buyers notably slipped. In 1996, the 'economic return' of these companies was half that of the non-acquirers.
But the hurdle over which mega-buyers often fail to stride is the huge premiums that many pay for baubles such as financial and media companies.
These make it very difficult for post-acquisition profits to clear the cost of the lavished billions in capital. The idea of 'economic value added', in which economic earnings are related to cost of capital, including equity, is a fashionable one. So long as the EVA stays negative, capital is being consumed. There's a strong correlation between this conspicuous consumption and a lagging share price value.
Such diversification is not always a blessing. The mega-merger is not always at an advantage in changing, fragmenting markets as overall market position does not always add up to the greatest profitability. Chrysler is third in the US car market but far more profitable than the two leaders, partly because it dominates the mini-van segment. Equally, in the pharmaceuticals sector, Astra was the second most profitable drug company in 1996, because of its leading position in asthma and digestive therapies. And Goldman Sachs has been lording it over the global M&A business despite its overall lack of mega-clout.
Even in segments, size need not equate with profits. One Siemens executive told the Wall Street Journal that his group had 'some businesses in which we are number three or number four and are making money. And we have some businesses in which we are number one and aren't making any money'. That may prove nothing except that some Siemens businesses are managed better than others.
A T Kearney's low-acquiring, high-earning stars followed a management formula of universal excellence. The key word is neither focus nor scale, but concentration. The aces have concentrated on very few specialities, such as marketing to the best consumer goods standards; core competencies; outsourcing heavily elsewhere; and intensive improvements in the R&D process.
The bigger and broader the scale, the tougher it is for managements to concentrate. The aggrandised giants could sub-divide into autonomous units, to bring concentrated marketing and innovation to their own segments. That might well work. But, then, why merge in the first place?
Robert Heller was founding editor of Management Today.