By A.T. Kearny
TransnationaleJuly, 2001
Drawing on our value-building growth database, which includes 25,000 listed companies in 24 industries and 53 countries, we analyzed consolidation activity from 1988 to 2000. The study determined the change in the Hirschmann-Herfindahl index, which reports on the CR3, or the market share of the three largest enterprises within an industry.
Hidden beneath the chaotic surface of mergers and acquisitions lies a distinct pattern that resembles an S-shaped curve (see figure 1). Each consolidating industry passes through four stages: o Opening o Focus o Accumulation o Alliance
The time frame from the first stage, in which an industry is somewhat fragmented, to the final stage, which is marked by significant alliance activity, stretches over approximately 20 years. Starting at a low level of concentration, an industry increases its merger and acquisition activity until saturation is reached. Toward the end of the cycle, streamlining and ultimately the formation of alliances move into the foreground. We describe in detail the characteristics and drivers of each phase in the following sections.
Opening phase
During the first phase of industry concentration, the fractured market is filled with players of all sizes. As a rule, the three largest suppliers account for a mere 10-30 percent of the market.
The emergence of new businesses or the advent of deregulation typically lies behind the fragmentation of market suppliers. Banks, airlines and utilities exemplify this trend. Telecommunications is another classic example.
Until the 1990s, telecommunications markets in most highly industrialized countries were largely regulated. But with the deregulation and liberalization of the telecommunications business, erstwhile monopolists lost their position as sole operators in the market. As obstacles to market entry began to fall, more and more competitors flooded the market. Then as cell phones gained popularity, even more rivals came onto the scene. Soon, the industry was highly fragmented.
For telecommunications, the largest mergers still lie ahead. The consolidation wave will be driven largely by the need to reduce costs via economies of scale. Fixed costs are unusually high in telecommunications, an industry whose infrastructure accounts for 50 percent of telephone costs. In response, the global telecommunications industry has already made its first moves toward the accumulation phase. Companies that act quickly as the next stage begins are more likely than their counterparts to come out on top.
Judging by telecommunications' growth portfolio, we expect consolidation to intensify and follow a pattern similar to what we have witnessed in other industries. More specifically, three to five large European service providers in the fixed-line business are anticipated to survive. The winners will most likely be those that can leverage their existing business, succeed with their chosen strategies and implement their plans effectively.
British Telecom is expected to lose influence in Europe, but France Télécom and Télefonica are potential winners. Smaller and mid-sized companies will either be wholly merged or join alliances. For them, the choice of when and with whom to merge will play a decisive role in their future success. The three major players will be surrounded by networks of large regional players, namely Telecom Italia, British Telecom and KPN. Small local companies are likely to merge. Télefonicás early move to get into relevant future markets has given the company an enviable headstart of about 10 years. Unfortunately, prospects are not as bright for Deutsche Telekom and Mobilcom. After roaring off to a fast start in the liberalized European market, the latter is now encountering growing difficulties. Mobilcom's partner France Télécom is financially strong but is not capitalizing on its full potential. Deutsche Telekom is an ambitious global player in cell phone services and has entered into partnerships in the Netherlands and Austria, but it is not considered a strong entry in the United States.
The experience of American telecommunications firm AT&T illustrates how quickly strategic missteps result in a negative impact. Six years ago the former U.S. monopoly was still a real giant, but it missed the trend toward consolidation, and today it is focusing heavily on catching up.
Accumulation phase
The second stage, the accumulation phase, represents a reversal of the first. The market begins to become less fragmented, and size begins to matter. As competitors grow, they realize two advantages. First, growth in the marketplace helps them realize their goal of reducing costs through greater economies of scale. Second, their larger size helps prevent a hostile takeover. This phase generally lasts for about five years until three of the largest suppliers account for 30-45 percent of market share.
The global chemicals industry, breweries and food services businesses are in this phase. Automobile industry suppliers are now on the threshold of a strong consolidation movement, thus following the footsteps of the automobile industry (which has already gone through this phase).
In the automotive supply industry, the three biggest players account for about 30 percent of the market. Mergers and acquisitions are part of the industry's daily fare as suppliers scramble to acquire the additional competencies they need to respond to shifts in responsibility along the value chain. The automakers, facing fierce competition themselves, are demanding customers, constantly pursuing lower costs and greater returns on investment. Today, car manufacturers increasingly outsource complete modules of a vehicle and are simultaneously reducing the number of modules needed to produce a vehicle. We expect that in the next five years automobile producers will work with just 10 modules (including roof, cockpit and doors) to build a car.
This shift in responsibility delivers a major challenge to most suppliers. Few are able to offer complete modules (and if so, only because they have merged). A supplier cannot assume responsibility for a module on its own since each module represents the combination of many different technologies.
Forecasts about who will win or lose following this wave of consolidation are based not only on growth potential, but also on the suppliers' opportunities for adding competencies.
In coming years, the number of suppliers is likely to shrink by one-third from the current level of 8,000. Surviving companies are also restricted by the number of manufacturers needed to make each module (we estimate four to five supplier conglomerates are needed per module).
Those who do not respond to industry dynamics risk being left behind. But those who choose partners carefully and strategically, and make a strong contribution to a module, stand an excellent chance of surviving the shakeout.
Focus phase
Following the accumulation phase the three largest players typically account for 45 percent of the market and now strive to solidify and reinforce their hard-won position. In the second phase companies have as a rule attained a size that puts them out of reach for a takeover. The consolidation process at this stage is not so much a question of mega mergers as the selective exchange of business units. The point is to strengthen core competencies and to clean up the company's portfolio, activities that lead to a slight linear rise in industry consolidation. Upon concluding the focusing phase and in transition to the fourth phase, the three market leaders have achieved a 60 percent market penetration.
Shipyards as well as the rubber industry are currently in the consolidation phase. The liquor industry has nearly completed it, having significantly streamlined its portfolio. Liquor companies are making aggressive additional purchases to secure the end of the available capacity, and they are beginning to forge the first alliances. Seagram, a global competitor, withdrew from the liquor industry-leaving its global whiskey labels like Chivas Regal and Crown Regal up for grabs. Diageo and Pernod-Ricard, two major suppliers, went to war to claim them. These two suppliers were not after growth; they were looking strengthen their core businesses. That turned out to be the basis of their deal to jointly acquire Seagram's wine and spirits business at the end of last year. Diageo, which had come into being three years ago through the merger of Guinness and Grand Metropolitan, adopted a new strategy, namely to concentrate on liquor, wine and premium beers. It sold its Pillsbury food subsidiary and acquired Seagram's wine business as a result. Diageo will expand its leading position in alcoholic beverages, while Pernod-Ricard will assume control of most of the whiskey labels, in line with its intention to strengthen and grow this sector.
In this way other companies or parts of them are being bought aggressively, but the growth is focused and strategic. The major players are fighting hard for certain business units, while disposing of others. Diageo and Pernod-Ricard demonstrate their focus on their key competencies quite clearly. In recent years, they have acquired the strength and size to put their strategies for product and market innovations to work.
Regional and local suppliers cannot muster such strength on their own. Increasing concentration in the trade is leading to lower average prices and higher marketing costs. Occupying a small geographical niche raises chances for survival since the liquor business-like the food arena in general-is also local and marked by highly differentiated consumer preferences. It is particularly critical that smaller suppliers shore up their brands and prices as a means of defending their niche for the long run. Semper Idem practices that diligently in Italy with its Underberg brand. Over the long term, it makes sense for local competitors to consider four alternatives: Operate a niche business, become a national market leader, develop a strategy of cooperation in the form of alliances and mergers, or exit the business.
Alliance phase
As we reach the end of the consolidation wave, the three largest market participants will have captured 70-80 percent of the market. The industry becomes apportioned and distributed; mergers and acquisitions become a rarity. Antitrust laws block further consolidation, and megamergers are out of the question. In addition, potential partners have long disappeared from the scene.
The battle for the biggest and best pieces of the market is over. Many former competitors have either become part of the family, parent companies or equal partners. The remaining companies become the object of alliances. The last acquisitions in the industry are still in the offing. Alliances are formed at all levels of the value-added chain. Cigarette manufacturers, automation and control equipment industry are classic examples of industries in this final phase of consolidation. The shoe industry, in the last throes of a powerful consolidation wave, also falls into this category (see figure S).
In the shoe industry, giants Nike and adidas-Salomon dominate the market, which is also inhabited by many small companies. The three biggest account for a market share of about 70 percent.
There is a distinction to be made between manufacturers in the public eye (like Nike, Adidas, Reebok and Timberland) and those less in the limelight (such as Salamander, Goertz and Bally). The latter have a strong regional focus. Since consumer preferences in the U.S. market differ significantly from those in Europe or Japan, predictions about the future of the industry are difficult. The consolidation stage attained by manufacturers has not been equaled by dealers, and this industry will continue to be fragmented in the foreseeable future. On the other hand, global manufacturers are already highly consolidated. Their keys to future success lie in the combination of strong brand identification and their ability to stay focused.
Not only does consolidation activity follow the same pattern and set of laws, it exhibits a surprising parallel to the movement of stock indexes. The Dow Jones Industrial Average moves in tandem with mergers and acquisitions (see figure 6).
Merger activities are highly dependent on stock movements. Rising stocks provide companies with considerable "acquisition currency." In addition, growing globalization and massive deregulation in some economic sectors affect consolidations to the same extent as stock market levels. They drive consolidations and stock prices. Consolidations, in turn, boost stock prices, for two reasons. First, top management is usually judged on its performance in terms of growth (which is the inevitable result of mergers). Second, mergers open access to international capital markets.
Aside from cross-industry patterns and phase-specific development, other factors serve to accelerate industry consolidation. Among the most significant are globalization, capital market pressures, the evolution of the technology infrastructure required to support networking, and the advent of the Internet.
The study reveals that globalized industries, like cigarettes or shipyards, tend to consolidate in quick, giant steps. Companies can achieve the greater value that capital markets demand through mergers and acquisitions. The technology infrastructure that enables companies to communicate outside their own walls also influences consolidation activity. As more and more industries invest more in software and telecommunications, economies of scale (and therefore the size of the company) become more important. Technological discontinuity also affects companies in every industrial sector. The Internet's communications and integration potential facilitates the management of complex enterprises, making larger mergers and acquisitions possible.
Conclusion
Within and throughout industries, there is clear evidence of a uniform consolidation pattern: Market fragmentation is followed by a potent wave of consolidation as companies strive to get bigger. Mergers decline once a certain degree of concentration has been reached. At that point, businesses focus on their core competencies until they no longer look for mergers or acquisition at the end of the consolidation wave, but choose alliances.
Consolidation is not random. Knowing the patterns and phases of merger and acquisition activity enables the knowledgeable players to understand the merger chess board in their industry, evaluate the players, and even forecast their movements. When companies consider the patterns that merger and acquisition activity follows, and recognize where their industries stand on the consolidation curve, they can proactively set strategic acquisition targets, execute accordingly-and emerge as winners.
FAIR USE NOTICE: This page contains copyrighted material the use of which has not been specifically authorized by the copyright owner. Global Policy Forum distributes this material without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes. We believe this constitutes a fair use of any such copyrighted material as provided for in 17 U.S.C § 107. If you wish to use copyrighted material from this site for purposes of your own that go beyond fair use, you must obtain permission from the copyright owner.
