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Mergers: magic or madness?

Published in The Week, May, 19th, 1996

Though mergers and acquisitions are an integral part of global corporate folklore, they have hitherto been uncommon in India. This has been due mainly to the restrictive laws that were a feature of the license-permit raj. The fresh breeze of deregulation and mercerization has swept much of the controls away. In the near future we are certain to see many more mergers and acquisitions. In that sense the HLL-BBLIL merger is a precursor of an entirely new genre in the corporate world.

A merger is the combination of two or more companies into one. Sometimes a new outfit is formed out of the two merging entities and at other times a holding company may be created to own the shares of both companies. Usually, however, a merger is achieved by the purchase of one company by the other. Shareholders of the acquired company receive shares in the merged company on the basis of an agreed ratio.

The land of mergers is of course the USA. American business and industry are consumed by periodic merger waves that alter the corporate landscape. Over the last hundred years, it has seen five waves of mergers-in the 1890s,1920s,1960s and 1980s-the fifth wave is currently on. The value of merger deals in the US in 1994 was over $200 billion. Some of the largest ever mergers happened last year, taking the total value of mergers to an astounding $325 billion.

Some of the deals that have had a tremendous impact around the world are: Disney Capital Cities/ABC, Time Warner/Turner (both in communications and entertainment), Chase Manhattan/ Chemical Bank (worth $10 billion in banking), Kimberly Clark/Scott Paper ($7 billion in consumer products), Upjohn/Pharmacia of Sweden ($6 billion in healthcare) and Union Pacific/ Southern Pacific ($ 5.4 billion in the rail road industry).

The latest in this frenzy is the Bell Atlantic/Nynex Corp merger that will create the second largest phone company in the US worth around $23 billion. It will also be the second largest merger in US history.

No single definitive reason can be attributed for merger waves; however several possibilities can be considered.

First, a merger wave can ignite when an industry changes as a result of revolutionary new technology, deregulation or price revisions. According to the University of Chicago economist Mark Mitchel, the 1980s wave was initiated in industries, which underwent structural changes.

Andrei Shleifer of Harvard University provides another possibility: waves happen when stock markets display an upward trend. During this phase, companies have more surpluses to invest in the purchase of other firms. Further, when stock prices are rising such decisions are unlikely to be disputed by shareholders. In fact, Shleifer points out that in pursuing mergers managers frequently violate shareholders' interests.

Reasons for mergers differ. In financial services, it can result in lower costs arising out of economies of scale; in entertainment the Information Age technology can provide vertical integration leading to increased market dominance; in power and telecom deregulation has raised competition and sparked off mergers again to increase market dominance; in health care mergers are expected to give suppliers bargaining power to negotiate better terms with customers; in transportation mergers increase profitability by slashing duplicated routes and overheads; and in the consumer goods sector, mergers provide more resources to succeed globally.

Mergers have always been touted for their ability to increase profits and efficiency substantially. But studies do not validate this assumption. Even during the first two waves, mergers did not jack up profitability. Instead, it attempted to consolidate monopolies within the same industry. This was repeated in the subsequent wave too.

Mergers did not result in increased efficiency either. The 1960s merger wave was especially bad-by the 1970s most of the merged companies were faring poorly. The 1980s wave was better and the merged companies fared better because they borrowed, took over the conglomerates formed by the 1960s merger wave and then proceeded to break them up.

The present merger wave is noteworthy for its brazen quest for market dominance. The explanation that the HLL-BBLIL deal is an entirely financial merger seems to be a smoke screen. The company is gearing up for possible competition from other MNCs by consolidating its stranglehold on the country's retail market.

Though media reports have stressed that HLL and BBLIL have different distribution channels, there is a substantial overlap in the retailers that both companies service. Very often the same retailer stocks personal products and food products, which account for a significant percentage of his sales. If one company provides the products that contribute to the lion's share of the retailers sales, that company is unassailable. Other consumer product providers are going to find it immensely difficult to obtain shelf space. Competitors of the new HLL are bound to be tightly squeezed!

While the HLL-BBLIL merger has caught the imagination of managers, many entrepreneurs wonder whether they can ever hope to grow to corporate size. Mergers do offer the possibility for smaller firms to expand their production, sales and presence in the market. No longer is it necessary for an SSI firm to spend decades at the same relative level. By embarking on a carefully planned merger program, the ambitious entrepreneur can quickly capitalize on the increased opportunities now available in India.

The Merger Wave of the1980s:

The current global merger wave is not based on financial considerations like hostile takeovers and leveraged buyouts. The objective is to build up strength to compete more forcefully not only in national markets but also in global markets. This is based on the realization that the entire business potential is coalescing into one global market. Management guru Tom Peters points to the declining importance of size as a determinant of success. Many giants are desperately trying to become even bigger.

What is really worrisome is that the merger phenomenon is now based on market dominance. The driving force behind this focus is the desire to eliminate competition. This is where governments will have to be super alert. Any attempt to preclude competition will immediately land us back to the pre-reform situation. The need to create a regulatory mechanism that will also monitor and encourage competition (an updated, modified MRPTC) is therefore pressing.

Ironically the desire to create mega-corporation contains within it the germ of destruction too. Innovative, flexible, customer-focused small competitors could wage guerrilla warfare and slowly but surely erode market share. Smaller competitors will not wage war in the trenches, they will opt for the hit and run strategy, namely niche marketing and constant product modifications and new product introduction. They will make product life cycles incredibly small so that the mega corporations are unable to compete on the time paradigm shift that will occur in consumer products marketing. Perhaps new channels of distribution will be opened up by aggressive new marketers; perhaps shopping malls and superstores will open and offer their own brands. Perhaps generic brands will capture customers.

By combing his vision with decisiveness, S.M. Datta has fashioned a mega-corporation. He certainly has won the marketing battle for HLL; but has the war been won?

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V.K.Madhav Mohan - The Leader : Mentoring Services, Mentoring Workshops, Mentoring products- Articles / Audio / Video/ Posters, Lectures