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THE "WHY" OF RECENT MERGERS

There may be some difference in the motivations behind recent mergers, as compared with those of earlier years. Several reasons for recent mergers can be identified.

A. According to the FTC, need for "additional capacity" motivated 2 out of 5 acquiring companies in mergers taking place between 1948 and 1954. In this connection, acquiring companies regarded mergers simply as one method of expanding productive facilities to meet growing demand. Our economic history indicates that in many cases a successful concern must expand continuously to obtain the advantage of economies arising out of increased volume, and to meet competition. Additional capacity may be obtained either by building new facilities or by acquiring existing facilities.

When considering these alternative means of obtaining additional capacity, the management of an expanding firm must make the decision in the light of several important economic questions, such as these

(1) How will the cost of constructing new capacity compare with the cost of acquiring already existing facilities?

(2) Will the additional capacity of the existing facility be materially greater than the immediate need?

(3) Does the potential growth in the demand for the firm's end products warrant an expenditure for facilities in excess of present needs?

(4) Are profit expectations from the additional facility sufficient to justify the risk involved in making the investment required in the purchase?

(5) Is the additional facility located advantageously as compared with possible building sites?

(6) Is the additional facility constructed in such a way as to make possible utilization of modern efficient equipment and methods?

(7) How will operation of possible new sites affect distribution costs for the corporation as a whole?

On top of these economic questions is superimposed the legal or political question: Will any new acquisition be legal?

B. Second in frequency as a reason reported by the FTC was "diversification of products,” which accounted for about 1 out of 5 consolidations.

The advantages of diversification are limited by the degree to which it is feasible for one company to produce different products. Questions have been raised about the trend toward diversification. Management, it is argued, would be most efficient when guiding production, promotion, and distribution of one product or a limited number of related products.

On the other hand, diversification of products may result in genuine economic advantages-from more continuous and efficient use of seasonal facilities and products, for example. Diversification by acquisition of existing facilities rather than construction of new ones may give the acquirer a market position immediately, without the promotional expenditures which would be necessary to establish that position.

Perhaps the principal advantage of diversification is the reduction of the risk of heavy losses from changes in the price of, or demand for, particular products. Generally, diversification offers a measure of protection from the decline in demand for particular goods. For example, during the past few decades, there has been a distinct shift in the consumption pattern for tobacco products—toward cigarettes and away from cigars, snuff, and chewing tobacco. Another example of the shift in consumer demand is the recent relative change from cotton textiles to synthetic fibers.

C. Our tax laws may also inspire mergers. The more favorable rates on capital gains, as compared with the rates on operating profits of corporations and personal incomes, encourage consolidation. The personal income tax rates which range up to 91 percent in top brackets have been a factor tending to make many mergers attractive for small business owners. Provisions permitting the carry-forward of operating losses as tax credits against future earnings, if the losing corporation should subsequently earn profits, also stimulate mergers, as does the high level of estate taxes.

D. Another important motivation in recent mergers has been the desire on the part of some efficient firms to make favorable investments of capital funds. Cor. porations with temporarily idle cash balances are always in the market for a means of putting that capital to profitable use. If such funds represent unused

working capital which the management wishes to keep liquid for possible future operating needs, temporary investment in securities of other companies may be desirable. Such investment might turn out to be the first step to eventual acquisition.

Ē. Mergers may be initiated, not only by the acquiring company, but also by the firm which is acquired. It may be more profitable for a weak company to merge with another firm than it would be to liquidate the company. Tax factors also motivate weak companies to seek to be purchased by another firm. In other cases, such a step is resorted to by businessmen advancing in age, and no managerial successors in view.

Any number of other motivations may be present in the current wave of merger activity-need for additional distribution outlets, acquisition of additional per. sonnel, desire to create conditions more conducive to raising equity capital and the desire for purely speculative gain.

Actually, these and other motives are interrelated. When a company official, an analyst or a Government spokesman, identifies a particular motive in a given case, this does not mean that others were not present. In some cases, the given reasons may differ from the real reasons.

Another significant fact about the "why" of recent mergers was noted by the New York Times (May 20, 1955):

"Another distinctive feature of the present movement is that the mergers, in most cases, are being initiated by management rather than outsiders or financial interests. The decisions are being hammered out in company board rooms-not in Wall Street."

Outside assistance, of course, is often secured for consummating merger plans. Indeed, Business Week (July 7, 1956) called "midwifing mergers” a “new trade" and described the growth of consulting firms whose principal or exclusive function is to assist merging companies.

MERGERS AND THE PUBLIC INTEREST

The important questions which ultimately must be faced in any discussion of merger trends are those of public policy. Do mergers affect the public in. terest Should Government place restrictions or merger activity if restraints of trade are, or conceivably could be, the result? What is the actual impact of corporate acquisitions on the competitiveness of the economy and on its efficiency in responding to consumer demands?

Distrust of mergers is sometimes similar to a more general distrust of bigness, particularly domination of an industry by one or a few large companies. In this view, a large company or one that accounts for a substantial share of the market, perhaps half of any industry's sales, is in a position to exert monopoly power simply because of its size.

Before examining the competitive consequences of mergers per se, therefore, it might be well to examine first the role of mergers in the growth of largescale business organization and the effects on competition of big business and industry "concentration."

BIG BUSINESS AND MERGERS

It is easiest to think of competition as taking place between a multiple of small enterprises competing vigorously to satisfy consumer demand of one product. Since this is the picture that is uaually called to mind by the word "competition," there has been a disposition on the part of some to feel that big business and competition are somehow incompatible, that large size alone enables a company to exert monopoly power.

To test the validity of this view, it is necessary to ask, how does a business get big and how does it hehave when big?

There are two ways for a business to get big : Externally or internally-through acquiring other companies or through expanding its own output and sales (through plowed-back earnings and liquid capital raised by selling securities). Several studies have tended to show that large-scale business organization in America has been built largely through the second method-internal growth resulting from expanded sales.

Weston study.-In an attempt to measure the relative importance of mergers as against internal business growth, J. Fred Weston studied the growth of 74 large firms from formation through 1948. His selection of companies in this study was confined to industries which were said to exhibit a high degree of "concentration"-i. e., industries in which mergers would be most significant in public-policy considerations.

The result, using 3 different methods of computation, showed that, on the average, only 36.3, 22.6, or 18.6 percent of total growth could be traced to external growth (acquisitions). Professor Weston found that 2 out of every 5 firms owned less than 10 percent of their expansion in assets to acquisition of other companies.

National chamber study.The National chamber's economic research department has conducted a survey, the results of which tend to reinforce Weston's findings. This survey covered the 10 largest manufacturing corporations (on the basis of asset size in 1955), with a view to determining how much their recent growth was due to expanded sales (internal growth) and how much due to mergers (external growth).

The survey of the 10 largest companies showed that only 6 percent of their growth from 1920 through 1955 was a direct outgrowth of mergers. It was impossible, of course, to determine how much these merged companies would have grown had they remained independent. But the study clearly indicated that the direct effect of mergers on the growth of these companies was demonstrably small. Actually, if the value of properties disposed of by these same companies is deducted from their acquisitions, the amount of growth directly attributable to merger activity was only 5 percent of the total growth of these 10 largest corporations since 1920. Furthermore, within the 10 largest corporations, no correlation between size and merger activity was shown. In General Motors Corp., for example, largest of the 10, growth by mergers was a lower proportion of total growth than for the average of the top 10.

Mergers as a percentage of total asset growth, 10 largest industrial corporations,

1921-55

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1 Corporations include, but not in the order listed: E. I. du Pont de Nemours, Ford Motor Co., Gen. eral Electric Co., General Motors Corp., Gulf Oil Corp., Socony Mobil Oil Co., Standard Oil Co. (California), Standard Oil Co. (New Jersey), Texas Co. and the United States Steel Corp.

2 Disposals exceeded acquisitions.

3 Totals represent total acquisitions of $1,620.5 million, total disposals of $269.9 million and total growth of $26,812.6 million.

The accompanying table shows that none of these big businesses owed its growth to mergers in the last generation. Rather, growth was internal.

Lintner-Butters study.--A third study of the importance of mergers in company growth came to a somewhat similar conclusion:

“For all manufacturing and mining companies during the 8-year period 1940-47, mergers were a much less important source of growth for large companies than for smaller companies * * *. To sum up, mergers have been responsible for such a small percentage of the total growth of large firms since 1940 that their effect on overall levels of industrial concentration has been very small (pp. 31-32)." 3

2 The Role of Mergers in the Growth of Large Firms. The first method of computation classified assets of initials years as external growth. The second classified initial assets as a base from which subsequent growth was measured. The third method treated initial assets as a separate component of growth. It would appear most logical to use the second method of computation, measuring growth from formation of the company, with the result that under 23 percent of total growth was a result of mergers.

3 The Effects of Mergers on Industrial Concentration, 1940–47, by John Lintner and J. Keith Butters, Review of Economics and Statistics, February 1950, pp. 30–48.

It is important to note just what these three studies show and what they don't show. They do not show all the economic ramifications which may or may not flow from one or a series of mergers. They do not show us what situation would have existed in the absence of mergers. They do show, however, that the direct role of mergers in the formation of large companies can easily be exaggerated.

In a critique of Weston's analysis, George J. Stigler attacks quantitative measures of the effects of mergers on several grounds, including: (1) The failure to take account of price changes, (2) the selection of firms to be studied, and (3) the failure of mathematical techniques to reflect adequately the economic forces at work.* Had Weston followed the procedures recommended in Stigler's first two criticisms, the results of Weston's research would not have been much altered. The third criticism, more basic than the others, leads us now to look at more qualitative analysis of, first, the competitiveness of big business; then industrial concentration; and, finally, the effects of mergers on competition throughout the economy.

BIG BUSINESS AND COMPETITION

It is apparent that business gets big primarily by internal growth, not by mergers. Its size may be thought of as a measure of its ability to compete with other businesses in meeting customer demands.

The use of bigness as a criterion of monopoly may have some rather startling reprecussions. Take a hypothetical industry, for example, in which one firm sees an opportunity to reduce costs and expand volume-to operate more efficiently so that it attracts customers, its sales boom and it grows in size. It might soon approach a level which, in the antibigness theory, would invite Government antitrust action.

How could such a firm avoid being labeled “monopoly”?

The answer seems clear. It would be compelled to play, paradoxically, the role of the monopolist—that is, to limit output, keep prices high, and hold back new products—the very action that would prevent growth.

Business in this country generally has not followed such policies. Instead, it has usually followed the more aggressive approach of expanding output. As a result, it has grown. Competition is probably more vigorous in the goods market today than ever before.

Even the industrial giants are not immune from the forces of competition. The Brookings Institution's study, Big Enterprise in a Competitive System, demonstrated dramatically that few corporations have managed to hold a position of dominance for very long. Of the 100 biggest corporations in 1909, almost half had fallen from that list by 1919. By 1948 only 31 were still on top. Of the top 10 corporations in 1919, only half remained there in 1948. One slid slightly to 12th in 1948. Two meatpacking companies slipped from the third and fourth spots to Nos. 30 and 27, respectively. Another company fell to 51st in 1935, recovering slightly to 37th in 1948. The 10th fell entirely from the list of 100 largest.

"The top would appear to be a slippery place," Brookings reported. Competition from new products, shifting consumer tastes, lax management, aggressive newcomers—these and many other forces constantly threaten the position of even the largest industrial giants. It would seem reasonable to conclude that big business operates in a competitive atmosphere.

INDUSTRY CONCENTRATION AND COMPETITION Critics of big business have been disposed to regard an industry dominated by a few large firms as lacking in competition. According to this view, an industry in which 2, 3, or 4 large companies produce 60, 75, or 90 percent of the industry's output is per se less competitive than an industry in which hundreds of firms compete, with no one firm accounting for more than 3 or 4 percent of the total market.

In many industries, “concentration,” as measured in this way, has declined in recent years. In the production of aluminum, for example, several firms now

George J. Stigler, The Statistics of Monopoly and Mergers, Journal of Political Econ. omy, February 1956.

6 This study, prepared under the direction of A. D. H. Kaplan and published by Brookings Institution, has been summarized in a 25-minute film presentation, also available from Brookings Institution.

compete where a few years ago only thrée occupied the industry and where, before the war, Alcoa was the sole supplier. In other industries, concentration may have increased.

If it were realistic to evaluate concentration on an industry-by-industry basis, it would be fruitful to examine various industries in more detail. However, since competition is never truly limited to any one industry, an understanding of the phenomenon of interindustry competition is essential to a realistic appraisal of concentration in American busi ess.

In many fields, interindustry competition has obliterated existing concepts of industries. This development has been due in part to the growth of new products, commodities which were unknown a generation or two ago.

An outstanding example is the textile field, where the long-established cotton, silk, and wool have recently met and competed with rayon, nylon, acetate, dacron, orlon, and countless other synthetics.

Not long ago, the competition among fuels was largely limited to wood and coal. Now consumers may choose between these and oil and gas natural and manufactured. Atomic fuels are on the threshold. Solar energy may not be far behind.

The 1955 Report of the Presidential Advisory Committee on Transport Policy and Organization noted the emergence, within a generation, of several competing modes of transportation, where one had dominated previously.

The Supreme Court (June 1956) determined that the Du Pont Co. production of 75 percent of all cellophane sold in the country did not constitute a monopoly, since the cellophane market constitutes only one-sixth of the total market for flexible wrappings.

The rising pace of technological progress continues to uncover new and improved raw materials and products and new uses for existing ones. The time between discovery and utilization of product and processes has been shortened. The high level of research and development expenditures promises to accentuate interindustry competition. No industry, no matter how tightly concentrated, is safe from this sort of competition. To take the narrow view that competitors are confined within the limits of an arbitrarily determined industry is to ignore realities. Going still further, one economist has put it, “There may be more competition between Cadillac cars and mink coats than between Cadillacs and Chevrolets." 6

For these reasons, many students of concentration and competition have questioned the use of concentration ratios which rely on static industry classifications.

A NOTE ON CONCENTRATION MEASUREMENT

There are many technical limitations to these concentration ratios. Say a firm produced automobiles and locomotives in a ratio of 60–40. This firm would be classified exclusively in the automobile industry. As a result, the degree of concentration in both these industries would be overstated. This firm's position in the automobile industry would be overstated by the inclusion of its locomotive production and the proportionate position of other firms in the locomotive industry would be overstated by the complete omission of this firm's locomotive production.

Many companies produce some or all of the parts, components, and subassemblies which go into their own final products. The former may never show up in other industry classifications. Industrial concentration studies are also vitiated for this reason.

In April 1954, the Federal Trade Commission submitted a report, the avowed purposes of which were (1) to measure changes which had taken place in the level of concentration during the past 15 years, and (2) to provide a base upon which future changes in concentration could be measured. In this report, the Federal Trade Commission concerns itself primarily with concentration ratios for 114 individual industries. Yet there are many instances among these 114 industries where substantial portions of primary products were turned out by establishments belonging to other industries."

For example, in the window and door screen industry, more than one-half of all wood screen doors and window screens were produced in other industries and therefore not counted in the concentration ratio.

& Stephen Enke, On Maximizing Profits: A Distinction Between Chamberlin and Robinson, American Economic Review, September 1951, pp. 574-575.

7 Changes in Concentration in Manufacturing, 1935 to 1947 and 1950.

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