The current boom in mergers and acquisitions in today's market seems to suggest that bigger is better. Not so. Here's why smaller companies have distinct advantages over giant conglomerates.
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You want to talk about merger mania? After reaching a record high of more than $1 trillion in 1996, the value of announced company mergers worldwide topped $1.6 trillion in 1997. More than half of that activity--$919 billion in 1997--was in the United States, where there were 10,700 mergers in 1997 and 10,340 in 1996. What's more, from 1988 to 1995, while the average number of companies grew by 10%--from 6 million to 6.6 million--the number of companies with more than 1,000 employees grew by 20%, from 5,000 to 6,000, faster than groups of any other size.
Behind those striking figures are the daily headlines you've certainly read, describing how already-large companies are combining to form truly mammoth ones, many of which seemingly dominate entire sectors. Raytheon's absorption of Hughes Electronics resulted in a single U.S. air-to-air missile maker. Columbia/HCA Healthcare Corp.'s acquisition of Value Health Inc., and Aetna Life & Casualty's marriage with U.S. Healthcare Inc., drastically reduced market competition among health-maintenance organizations.
Add to all that the consolidation from below--the so-called "roll-up" or "poof" companies that combine small operations in areas like printing, waste hauling, and video rentals into bigger, publicly traded enterprises. "Poof!" says one consolidator with a successful record of marketing roll-ups to investment-hungry Wall Street, "you have a company." While recent accounting-rule changes may dampen roll-up activity, efforts to consolidate many traditional types of small businesses, such as drugstores and veterinarians, contribute to the sense that the days of the "little guy" are numbered.
So if industry after industry is being rolled up into just a handful of mammoth companies, and Wall Street is pouring billions into "big-cap" stocks and ignoring the rest, shouldn't the 1990s be thought of as the Age of Big?
Hardly.
Recent consolidations in sectors like tire businesses and railroads have been, at least at first, disastrous. There have been cases in which new train companies couldn't even keep track of where their engines were. And even the well-publicized struggles of small businesses like mom-and-pop druggists may sometimes have been overstated. In 1980, 13 chain-drugstore companies operated 200 or more stores; today there are only 10 chains. In the same period, the number of drugstore chains with more than $75 million in revenues fell from 43 to 33. From 1988 to 1995, the total number of drugstores did fall, but only by 12%, from 50,000 to 44,000. From 1993 to 1995, a period in which small companies really felt competitive heat, payrolls for the smallest drugstores, with just one to four employees, actually increased by 8%, more than the industry average. Consolidation is happening, to be sure, but it hardly heralds the death of independents.
Let's face it: "big" just isn't what it used to be. The U.S. economy is no longer an atomistic, libertarian free-for-all in which the biggest player is likely to be the strongest. Even the largest and smallest businesses must form enduring links--strategic alliances, supply chains, project-specific work teams--to survive in constantly changing markets. Modern production networks comprise truly gargantuan organizations that dwarf even the largest merger, but what makes them tick is collaboration, constant learning, and unique compensation and authority structures, not size. Still, it's easy to understand why some might think otherwise.
Big Investors Build Big Illusions
So what accounts for our current merger mania and Wall Street's big-company infatuation? The answer is that mutual-fund money and huge institutional investors have profoundly changed the investment criteria that motivate highly public financial markets. In the past, company performance and skill were the primary factors guiding where money was spent. Today the things that matter are liquidity and name recognition.
When money flooded into mutual funds through retirement, pension, and other savings accounts, fund managers had to find ways of investing huge sums without driving up the price of the stocks they wanted to buy. "You just can't buy small-cap stocks as efficiently as big-caps," explains David Shulman, formerly the chief equity strategist for Salomon Brothers and now a general partner at Ulysses Management. The managers also wanted to be able to sell their holdings as easily as possible if they needed to raise cash.
Over the past five years, billions of dollars shifted into the biggest companies' stocks because they had the largest number of shares on the market, as well as brand-name recognition. Since 1994 the proportion of cash invested in "big-cap" index funds--those consisting of only large-company stocks--has risen from just 3% of total mutual-fund investments to 20%. "The market is willing to pay a premium for liquidity and so-called quality," explained one fund manager, John Bogle Jr. of Numeric Investors, to the Wall Street Journal. "And that's going to benefit the larger companies."
Merger mania was largely a direct result of Wall Street's preference for liquidity. Companies saw they would be rewarded for meeting the new criteria, and fund money provided the cash to do big deals. As companies' stock prices rose, moreover, they could use their own equity as currency to do their own mergers and acquisitions, trading stock for businesses.
Consolidation and stock-price appreciation began to feed on each other. Through layoffs, recapitalizations, and growing industry market shares, newly merged companies could often dramatically improve earnings and balance-sheet ratios. In the quarter-by-quarter time frame that governs public equity markets, those achievements seemed to justify even greater stock-price appreciation.
