Advisory Board Notes: James Brock on Merger Mania

Nov 10 2005
Publications

With Permission of the Multinational Monitor JULY/AUGUST 2005 - VOLUME 26 - NUMBERS 7 & 8

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Merger Mania and Its Discontents The Price of Corporate Consolidation

by James Brock

Spurred by lax antitrust enforcement and burgeoning laissez-faire dogma under Democratic and Republican administrations alike, the U.S. economy for two decades has been consumed in an epic corporate merger and consolidation movement.

Broad statistics tell part of the story: The dollar value of corporate mergers and acquisitions amounted to $1.4 trillion during the 1980s, exploded to $11 trillion during the 1990s, and continued at a frenetic pace of $7.6 trillion during 2000-2003 (including $3.4 trillion in 2000 alone) — adding up to a combined total of $20 trillion of corporate mergers and acquisitions over the past 25 years.

These aggregate sums can be put in perspective by considering that the $20 trillion spent on mergers and acquisitions exceeds the total amount of all private nonresidential investment in the United States over the same period. It is 10 times larger than the $2 trillion U.S. industry spent on research and development during the past 25 years. It is twice the value of the U.S. annual gross domestic product (the value of all goods and services produced) in the year 2000; triple the country’s GDP in 1990; and 10 times the U.S. GDP recorded in 1980.

Behind these aggregate dollar amounts has been a cumulative succession of ever-larger mega-mergers combining the biggest firms in one major field after another, aggrandizing concentration of economic decision-making throughout the economy.

Corporate pac-man

The nation’s food chain provides one example of the dramatic U.S. industry consolidation over the last quarter century. In raw foodstuffs, mergers among the nation’s largest grain firms — including Cargill’s acquisition of Continental Grain, and ConAgra’s purchase of Peavey and Standard Milling — contributed to giving four firms control over more than 60 percent of the nation’s grain business.

In meatpacking, ConAgra’s acquisitions of Armour Meats, Swift, Monfort, E.A. Miller and Northern States Beef, coupled with Cargill’s purchases of Spencer Beef and Sterling Beef, have played a key role in raising the four largest meatpackers’ market control of the field from 28 percent in 1980 to 70 percent or more, and concentrating control over vast swaths of the nation’s raw foods and crops in the hands of a few giants.

In processed foods, mega-mergers have concentrated control among the nation’s largest food manufacturers. During the early 1980s, General Foods (Post cereals, Maxwell House, Jell-O, Minute Rice) acquired Oscar Mayer and Entenmann’s bakery products, while cookie and cracker giant Nabisco merged with Standard Brands (Planter’s nuts, Baby Ruth and Butterfinger candy bars). In the mid-1980s, General Foods was acquired by Philip Morris, while Nabisco was acquired by RJ Reynolds. Then-Philip Morris absorbed food giant Kraft in 1988, and in 2000 purchased Nabisco and combined it with Kraft. In the same period, General Mills (Betty Crocker, Cheerios, Wheaties, Yoplait yogurt) doubled its size with an $11 billion acquisition of Pillsbury, obtaining the leading position in a raft of major food product categories; Nestlé acquired Carnation; while Unilever and BestFoods (Hellman’s) also merged together.

And at the retail end, grocery giants have done the same: Food-4-Less and American Stores merged their substantial grocery retail operations in 1991 in a $248 million deal. Three years later, Food-4-Less merged with Ralph’s Grocery, a major Western chain, in a $1.6 billion deal. Ralph’s, in turn, was acquired in 1997 by another major Western grocery chain, Fred Meyer, in a $3.1 billion deal. The cycle continued the following year, when Fred Meyer was acquired by Kroger — the nation’s largest grocery retailer — in a $12.8 billion deal. Other leading chains, including Safeway, have also engaged in absorbing their rivals, so that the combined share of national sales controlled by the five largest grocery chains jumped from 26 percent in 1980 to nearly one-half by 2004; the share of the top 10 chains has risen above 60 percent; and in some major states, the four largest grocery chains have come to control as much as 70 to 88 percent of all retail grocery sales.

In petroleum, oil titans Exxon and Mobil merged, compelling a new category of “super-majors” for classifying firms in the field. British Petroleum acquired Sohio in the 1980s, and bought Amoco and Atlantic Richfield in the 1990s. Chevron acquired Gulf Oil in the 1980s, merged with Texaco in 2001, and is now negotiating to absorb Unocal. Phillips Petroleum acquired Conoco along with Tosco, one of the nation’s leading (and last) independent refiners. The result, according to no less an authority than Lord Browne, chief executive of British Petroleum, was that “[m]any of the components of old Standard Oil Company had been brought together” — a substantial step, in other words, in resurrecting the Standard Oil Trust of a century ago!

Pharmaceuticals, too, have been the scene of sustained merger and consolidation among the nation’s and world’s biggest drug firms: SmithKline merged with Beecham in 1989 in a $14 billion combination; pharmaceutical giants Glaxo and Wellcome merged in 1995 in another $14 billion deal; and the two giants resulting from these combinations, SmithKlineBeecham and Glaxo Wellcome, merged with each other in 2000. Pharmacia — itself an amalgamation of formerly independent producers — merged with Upjohn in 1995 in a $7 billion combination, and subsequently acquired the drug-making operations of Monsanto and G.D. Searle. Meanwhile, Pfizer acquired the Warner-Lambert pharmaceutical firm in 1999. Then, in 2002, Pharmacia and Pfizer merged. Other mega-mergers include Bristol-Myers and Squibb ($12 billion deal), Ciba-Geigy and Sandoz ($30 billion merger), and Astra and Zeneca ($36 billion deal). U.S. pharmaceutical giants also acquired the nation’s largest prescription benefit management companies — firms that threatened to curb the giants’ unparalleled pricing power by negotiating for the prescription needs of millions of patients covered by health insurance plans.

In defense weapons, mergers have concentrated control of the field in the hands of a powerful oligopoly of producers: Weapons operations of Unisys, IBM, LTV and Ford were merged into the Loral Corporation, which was purchased by Lockheed, which then merged with Martin Marietta to create the Lockheed Martin colossus. Northrup, Grumman and LTV’s Vought aircraft division merged to create a second giant, Northrup Grumman. A third dominant firm, Raytheon, arose by merging the defense operations of General Motors, Texas Instruments and Chrysler, among others. Meanwhile, Boeing acquired McDonnell Douglas, the only other U.S. producer of commercial jet aircraft, as well as Rockwell’s aerospace and defense operations. As a result, the number of competing producers of major weapons systems has plunged, from 13 to three in tactical missiles, from eight to two in fixed-wing military aircraft, and from six to two in space launch vehicles.

Banking and finance has witnessed the same scene of cumulative consolidation: Through two decades of ever-larger acquisitions, NationsBank became one of the country’s largest commercial banking concerns, absorbing C&S/Sovran (itself a merged entity), Boatmen’s Bancshares ($9.7 billion deal), BankSouth and Barnett Bank ($14.8 billion acquisition). Then, in 1998, NationsBank struck a spectacular $60 billion merger with the huge Bank of America, which itself had been busily acquiring other major banks. The merger between NationsBank and B of A created a financial colossus controlling nearly $600 billion in assets, with 5,000 branch offices and nearly 15,000 ATMs. Bank of America then proceeded to acquire Fleet Boston — which had just completed its own multi-billion dollar acquisitions of Bank Boston, Bay Bank, Fleet Financial, Shawmut, Summit Bancorp and NatWest. Giants Banc One and First Chicago NBD — their size the product of numerous serial acquisitions — merged, and the combined entity was subsequently absorbed by J.P. Morgan which, in turn, had just acquired Chase, after the latter had merged with Manufacturers Hanover and Chemical Bank in the financial business of underwriting stocks and bonds. Other mega-mergers include the $73 billion combination of Citicorp and Travelers Group in 1998, as well as the acquisition of leading brokerage firms by big banks, including Morgan Stanley’s ill-fated acquisition of Dean Witter.

Meanwhile, in radio broadcasting, $140 billion worth of stations, representing some 26,000 individual properties, were bought and sold over the 1982-2002 period. The annual value of announced radio mergers peaked at $3.4 billion in 1988, temporarily subsided, and then shot up to $41 billion in 1999 in the wake of a deregulatory provision furtively smuggled into the sprawling Telecommunications Act of 1996. The leader of this concentration parade has been Clear Channel Corp.: Originally a small concern operating 17 stations, Clear Channel spent $30 billion acquiring more than 1,300 individual radio stations. Viacom was the second largest consolidator, spending $13 billion to acquire 164 stations. Whereas the nation’s largest radio broadcaster operated 54 stations in 1996, six years later Clear Channel operated 22 times that many; the number of stations owned by the 10 largest radio firms exploded from 371 in 1996 to more than 2,300 just six years later. Today, the biggest radio broadcast firm controls an estimated 40 percent or more of revenues in the nation’s largest 186 local radio markets, while in 97 top markets, two broadcasters together control more than 80 percent.

The foregoing are illustrative of the cumulative, radical restructuring wrought throughout the U.S. economy through mega-mergers. Others include: automobiles (Chrysler acquired by Daimler, with additional partnerships involving Mitsubishi and Hyundai; Ford acquiring control of Volvo, Land Rover, Jaguar and Mazda; General Motors’ acquisition of Saab, and joint ventures with Toyota, Subaru, Isuzu and Suzuki); telecommunications (Southwest Bell acquiring Ameritech and Pacific Telesis; Bell Atlantic and GTE merging to create Verizon; MCI merging with WorldCom; Cingular acquiring AT&T Wireless; and Verizon’s pending acquisition of the remains of the collapsed MCI-WorldCom organization); airlines (dense web of alliances and partnership pacts between major U.S. airlines and the world’s leading foreign carriers); and accounting and auditing, where the Big Eight merged in the 1980s to become the Big Six, which merged in the 1990s to become the Big Five, which became the Big Four following Andersen’s 2002 collapse as a result of its involvement in the Enron scandal.

The bigness complex economy

What has a quarter century of consolidation achieved? First, it marks a monumental opportunity cost of $20 trillion spent shuffling paper ownership shares for existing facilities and firms that, instead, could have been invested in researching new products, developing new production methods, and building new production plants equipped with state-of-the-art technologies. In petroleum, tens of billions of dollars spent by oil giants to merge with each other is, at the same time, tens of billions of dollars not spent finding new petroleum reserves, not expanding the nation’s woefully overburdened refinery capacity, and not researching and developing new alternative-energy technologies.

Second, mega-mergers have utterly failed to deliver the cornucopia of efficiencies, economies and “synergies” glowingly proclaimed by their lavishly compensated promoters. Instead, merged leviathans have become mired in the bureaucratic morass that characterizes diseconomies of extreme organizational size and scale. The first five years following the Chrysler-Daimler merger, for example, saw a sharp deterioration in Chrysler’s performance, including billions of financial losses; once Chrysler seemed to be righted, more recent years have seen the Mercedes side of the merged firm suffer serious setbacks in product quality and market appeal. Combining the increasingly empty new-product pipelines of drug giants via mega-mergers seems to have succeeded in creating even bigger, even more empty new-product pipelines — so much so that “Big Pharma” has been increasingly turning to smaller, more advanced outside firms for innovative new medicines. The stupendous merger of AOL and TimeWarner “succeeded” in destroying an impressive $200 billion of the market value of the merged firm’s stock.

Meanwhile, the financial “supermarkets” merged together by financial giants fostered profound conflicts of interest, which the merged firms mercilessly exploited in fleecing millions of individual investors in promoting sales of the stocks of Enron, WorldCom, Global Crossing and other firms that they secretly knew were collapsing.

Third, consolidation has exacerbated market power throughout the economy. In food, it has spawned U.S. congressional charges that powerful oligopolies of grain buyers and meatpackers are exploiting farmers and ranchers, and that a handful of grocery giants collectively monopolize the nation’s retail shelves. In radio, it has afforded a handful of giants vast influence in dictating what political views and voices are — and are not — heard; what types of music are — and are not — played; and which musicians and concerts are — and are not — successful. In energy, it has enhanced the power of Big Oil (as explained in the confidential document of one oil giant) to “short” regional gasoline markets and “leverage up” prices by deliberately directing supplies elsewhere (or as Enron personnel put it in less technical terminology, “to jam $250 a megawatt hour electricity up Grandma Millie’s ass”).

Fourth, this kind of consolidation renders society more dependent on — and more vulnerable to abuse by — fewer, even more mastadonic organizations. Thus, consolidation of defense weapons production during the 1990s has been followed by a subsequent flood of contract corruption and fraud, as well as astronomical hikes in the procurement costs of major weapon systems. Similarly, consolidation in accounting and auditing may effectively have immunized the four remaining giants from prosecution for criminal wrongdoing, for fear of concentrating control of the field even further.

Fifth, the “super-sizing” of U.S. firms through mergers produces organizations so big, and with operations so far-reaching and affecting the lives of so many, that as a matter of practical politics they come to be considered too big to be allowed to fail. Despite his libertarian leanings, even Fed Chairman Alan Greenspan has expressed deep concern about the “reality that the megabanks being formed by growth and consolidation are increasingly complex entities that create the potential for unusually large systemic risks in the national and international economy should they fail.” Extreme giantism thus threatens to erect an Alice in Wonderland world of reverse economic Darwinism, where survival is assured for the fattest, not the fittest, and for the biggest, not the best.

Last but not least is the far-reaching political influence these vast bigness complexes exert on a democratic government designed to be responsive to pressure.

In a recent interview with the Wall Street Journal, British Petroleum’s Lord Browne offered a telling assessment of this important point: “We do get the seat at the [political] table,” he observed, “because of our scope and scale. Whether we are the second or the third largest oil company is of very little import, but we’re certainly up there and we operate in places which are important to the United States government, and the United States government is important to us. Both. We have large numbers of employees in the United States. That’s very important in a political system. And they are highly concentrated. So we have a very significant presence in Texas, Illinois, Alaska, California. These are important because our employees are voters. And our activities help to create jobs. And help to create communities.”

In this way, merged bigness complexes become states within the state, but with no explicit system of checks and balances to guard against the abuse of their influence.

It is more than a little disquieting to consider the consolidation of the U.S. economy over the last quarter century with another stupendous economic development of the era — to wit, the rejection of the centrally controlled economy in the former Soviet Union, across Central and Eastern Europe, in China and elsewhere. It is supremely ironic that U.S. business should embrace through merger the kind of centralized economic architecture that these others have desperately longed to dismantle. It is a reminder, once again, of the aphorism that sometimes the greatest challenge is to protect free enterprise from its friends.

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James Brock is Moeckel Professor of Economics at Miami University in Oxford, Ohio. He recently published an updated new edition of The Bigness Complex: Industry, Labor, and Government in the American Economy, originally co-authored with Walter Adams, and is editor of the eleventh edition of The Structure of American Industry.