Lately, there’s been lots of press about mergers. With the economy listing, reports are rife that retailers need to merge to survive. Airlines need to merge to survive. And now we read beer brewers need to merge to survive (read article in Chicago Tribune here). Is this true? Do these businesses have to merge to survive?
Most mergers are based on the simple idea of "economy of scale." This is a very Industrial Revolution idea that the company with the biggest manufacturing plant has the lowest cost – and thus wins! Advocates claim that you keep buying competitors so you build more volume in order to spread out marketing, advertising, administrative (accounting and legal for example) costs over more volume – because these costs don’t need to rise as fast as volume (in their estimation). Similarly, within manufacturing or operations there will be costs that don’t rise as fast as volume, and thus the biggest volume competitor should end up with the lowest per-unit cost. And this supposedly leads to victory because the low cost competitor always wins. As though product differentiation, service differentiation and other factors are irrelevant.
In the case of beer, we’re now expected to believe that unless a company has the most beer volume GLOBALLY they can’t afford to stay in business – so poor Budweiser (see chart here) with its multi-million case annual production is such a small fry it’s going to become toast. Do you really believe that? Will combining Budweiser with a Belgian and Chinese brewer suddently, somehow, make Budweiser a more profitable brand? Just because its parent has more global market share?
Well, we all know we know longer compete in an industrial economy. Today, economies of scale advantages are pretty rare. Competitors can get 99% of scale advantages at pretty low volume by sharing resources – from ad buys to distribution centers to trucks and manufacturing plants. Furthermore, there are lots of people out there wanting to invest in "hard assets" so finding money to expand facilities is very cheap – leading to the lowest capacity utilization for fixed assets in American history! Plants aren’t busting with volume as they expand. Quite the contrary plants are regularly being closed to consolidate capacity into other locations! Economies of scale are a proven concept – but having them as a competitive advantage is another point entirely. We now compete in an information economy where the rules are entirely different than before.
So why all this merger mania? Firstly, because so many people believe in economy of scale advantages (which worked really well in the 1960s and 1970s) they keep believeing in them even though they no longer exist. And because merging is something a CEO can drive from his own office. If he runs a company wtih $100 revenue, and he buys another with $100 revenue, he now controls more people, more plants, more costs, more revenues – and by gosh hasn’t he done competitively well? He’s taken over the competition, and made his company bigger and doesn’t that mean competitive success? Given how we hero-worship the CEOs of large companies, and provide more hero attributes the largest of these, we demonstrate regularly that we think of a merger buyer as the "winner" and the merged company as a "loser." But is that true when the only growing beer brands are the craft beers and they are considerably more profitable than the traditional part of the business? Isn’t it time to focus on a different way to compete if we want profitable growth?
Does merger activity produce better products, lower prices, better customer satisfaction, lower cost, more jobs, better communities and higher returns for investors? Oh my, but this are tough questions. Virtally all academic studies of mergers have shown the opposite. The merger reduces product innovation and new product launches, creates higher prices (in fact that’s the objective of airline mergers), lower customer satisfaction, create little change in per unit cost (it goes up more often than down), fewer jobs as layoffs dominate, and investors of the "winning" company receive nothing for the effort.
We have to move beyond out-of-date ideas like "economy of scale advantages" if we’re going to break out of the no-growth, no-jobs economy dominating the U.S. since 2000. We need to use Disruptions to drive new ideas, and implement White Space to test them.
Illinois Tool Works (see chart here) has demonstrated that companies can be very successful with mergers. Acquisitions aren’t inherently bad. But they are if they are done for the wrong reason – like economy of scale advantages. Instead, ITW uses mergers need to make better products, improve customer satisfaction, develop more new products and launch them leading to better revenue growth and better cost/price performance leading to higher profits for investors. Mergers can be very valuable to successful strategy – but they have to be well designed, thought through and managed for those results – not merely assumed to produce lower cost because volume is being consolidated.