Is Bigger Better?

Unit of One

It's in the headlines nearly every morning: the urge to merge. Each day heralds a new marriage between colossal companies - creating a merger- and-acquisition frenzy unrivaled in history. This year we've seen a grand total of 10,401 worldwide deals, with a price tag of $1.3 trillion, which raises an interesting question: Is bigger really better?

Conventional wisdom explains these deals in terms of strategy, scale, and globalization - and stops there. We invited 12 influential thinkers and leaders to peel back the merger issue by answering three different questions: Will these megacorporations really work and succeed over time? Who will want to work with them? And will they work for us - what does this new cast of corporations mean for business and society? After you've considered these leaders' answers to the meaning of mergers, ask yourself, Is bigger really better?

Will They Work?

Ralph Nader

Consumer Advocate

Washington, DC

The central challenge for any company, regardless of its size, is to keep doing a better job for its customers. These megadeals have nothing to do with serving customers. So what's driving them? Greed, ego, and a dangerous can-you-top-this complex that I call "little boys looking for bigger toys."

One way to understand what's behind these mergers is to watch the press conferences in which they get announced. The two CEOs always make the case for greater efficiencies, more synergies, heightened productivity - in other words, what's in it for investors. How often do they describe what's in it for customers? When is the last time two giant banks merged and announced that they would reduce extravagant ATM fees? When is the last time two big companies from any industry merged in such a way that consumers said, "Hey, this deal is for me"?

And look at the compensation that CEOs receive as a result of megamergers - severance agreements or stock-option packages worth tens of millions of dollars. Don't tell me that payoffs this huge don't factor into the nonmeritorious calculations behind these deals. Now add the fact that more and more of these transactions are stock-for-stock deals - often with no cash changing hands - and the urge to merge becomes irresistible.

During the 1980s, at the height of the LBO frenzy, at least deal-makers had to turn to the financial markets to raise equity capital or issue debt. That reality imposed certain financial checks and balances. Today companies just issue more shares. CEOs can do megadeals with free money!

There is a soft underbelly to these megacorporations. It's called remoteness from empirical reality, overextension in every way: too much bureaucracy, too much hierarchy, rivalries between formerly independent operations. Just think: How much time will the leaders of these companies spend improving the quality of their products or devising new ways to serve customers? Very little. They'll be too busy wrestling with internal politics and figuring out whom to buy next, or whom to be bought by. And consumers will pay the price.

Ralph Nader has been an activist for grassroots democracy and consumer rights for more than 30 years. His first book, Unsafe at Any Speed inspired breakthrough auto-safety legislation. He has also promoted advances in clean water, occupational safety, antitrust enforcement, and campaign-finance reform.

Karen Stephenson

Professor

John E. Anderson Graduate School of Management, UCLA

Los Angeles, California

It is hard to deny that most big mergers are motivated by short-term financial gain for a small group of people. America is the short-term-thinking capital of the world. Our entire financial structure - with markets driven on a quarterly basis - is geared toward the short-term, and this fact heavily influences our thinking. Because we live in a big country, we tend to focus on an obvious characteristic: size. But smart businesses recognize a more important characteristic: structure. When the hierarchies of behemoths merge, they discover that they buy inefficiency through size - and then try to become more efficient. In contrast, the networks of effective organizations achieve scale through efficient structures.

The effectiveness of networks is apparent in another species of big mergers: companies that merge to create babies. These little offspring can tolerate big risk. They are agile and adaptive. Look at the merger between Shell and Mobil that spawned Aera Energy - an autonomous, creative, and highly profitable amalgamation of the two giants. A big part of Aera's success is a result of the careful extraction of the right DNA from both parents and the creation of a separate, effective network.

Networks succeed by being highly adaptive and agile. They learn to disperse innovation through autonomous subsidiaries. They're constantly stirring things up, moving people around, and cross-training their executives. Behemoths, on the other hand, tend to inbreed. They create separate silos that compete against and eventually cannibalize each other. But this giantism is a short-lived phenomenon. In another five years, we'll be riding the wave of their demergers.

Karen Stephenson (karen.stephenson@anderson.ucla.edu) is also president of NetForm, a company featuring Mercator, software that measures and maps knowledge networks in organizations. She is a contributing member to three international think tanks: Global Business Network, The Agora, and Cultural Survival.

Peter J. Solomon

Founder, Chairman, and CEO

Peter J. Solomon Co. Ltd.

New York, New York

There are four explanations for the current merger-and-acquisition phenomenon. First, some mergers are driven by changes in government policy - for instance, policy changes in health care that are altering the distribution and payment systems of health services. To defend their positions in this field, companies congeal. Second, mergers often occur from a need to be a bigger countervailing power. As retailers get bigger, they put more demands on product companies that must meet their terms - and often, their size. Third, some mergers are driven by price reductions. And a fourth kind of merger, those within the banking and airline industries, are made because the companies need to be able to follow clients around the globe.

So everyone is getting bigger. The real question is not whether companies are getting "better" - that's a hard term to define - but whether they're becoming more efficient. Sometimes being bigger can yield better efficiency. For instance, we just advised Office Depot to buy Viking Office Products. This merger would allow Office Depot to move into the international market quicker than it could on its own, and to open a new line of direct selling. I think that makes them better and more efficient.

The downside of getting bigger is becoming more bureaucratic. It takes a great management team to prevent this. Many mergers fail because it takes a lot of work to merge cultures successfully. People run out of energy, systems, information, or talent. When you reach a certain size, you can outgrow your ability to be innovative. But at that point you can rely on market force. And force can overcome innovation for a hell of a long time.

Peter J. Solomon (pjs@pjsolomon.com) was a managing director of Lehman Brothers Inc. and played a role in the merger of Lehman Brothers with Kuhn Loeb to form Lehman Brothers Kuhn Loeb - acquired, in 1984, by Shearson/American Express. Solomon was chairman of the merged company's mergers- and-acquisitions department before leaving to found Peter J. Solomon Co. Ltd., which provides investment-banking services to companies.

Joanne Lawrence

Managing Director

JT Lawrence & Co.

London, England

Most companies merge for strategic reasons - a need for geographical presence and scale. But most mergers are not executed strategically. A major reason for the high rate of merger failures is a failure to create a new culture. So the question is not, "Is bigger better or worse?" but, in the end, "How does the big company run itself?"

The key to a strategic merger is to create a new culture. This was a mammoth challenge during the SmithKline Beecham merger. We were working at so many different cultural levels, it was dizzying. We had two national cultures to blend - American and British - which compounded the challenge of selling the merger in two different markets with two different shareholder bases. There were also two different business cultures: One was very strong, scientific, and academic; the other was much more commercially oriented. And then we had to consider within both companies the individual businesses, each of which had its own little cultures.

To make the merger work, we found that we had to develop an attitude that says, "This is a new company. Things will be different." Then we had to represent that symbolically in everything we did - from the vision and behavior of the leaders down to the logo of the new company on each employee's paycheck.

Joanne Lawrence (jt__lawrence@compuserve.com) played a key role, as vice president and director of communications and investor relations at Smith Kline Beecham, in the 1989 merger between the U.S.-based pharmaceutical company SmithKline Beckman and the Beecham Group, a diversified consumer-oriented company headquartered in the United Kingdom. This merger was one of the most successful and largest transatlantic equity swaps in business history.

Who Will Want to Work with Them?

David Dorman

Chairman, President, and CEO

PointCast Inc.

San Jose, California

Mergers are very tempting. For a CEO, the financial logic of merging is often irresistible, especially in the telephone industry. When I was CEO of Pacific Bell, we realized that it almost didn't matter who we combined with - be it with one of the other Bells or with GTE. Just by merging, we could eliminate about $1 billion a year in annual expenses while creating very powerful operating and strategic synergies, providing global reach, and increasing overall scale. So the math is pretty powerful.

But this argument has holes when it comes to the logic of talent. Young rising stars are much more interested in working for small, fast companies than enduring the lengthy Darwinian selection process that big companies impose on them. Too many fast companies can compel talent by offering all the entrepreneurial bells and whistles: stock options, fun and challenging environments, frequent promotions, and the adrenaline rush that comes from taking risks. That talent issue is the Achilles' heel of the behemoths.

The merger-and-acquistion frenzy has had another big impact. It has changed the business environment in Silicon Valley. You now are seeing fewer starry-eyed entrepreneurs - and more opportunists who are looking for places to create value, but who don't expect to be running the company for the next 50 years. I call these roving bands "opportuneurs" - hybrids of opportunistic businesspeople and entrepreneurs. They are part of a fundamental shift in the startup world.

David Dorman lived through the 1996 merger between Pacific Telesis and SBC Communications Inc. - one of the largest mergers and acquisitions in corporate history - to become executive vice president of the merged company. Currently, Dorman heads PointCast, an Internet news and information service.

Charles B. Ames

Operating Partner

Clayton, Dubilier & Rice inc.

New York, New York

The real issue is not size - whether bigger or smaller is better - but focus. While the notion of economies of scale is a valid argument to explain the frenzy of mergers and acquisitions, the more important question that we need to ask is, What is that scale?

When I was CEO of Goodrich Tire, our competitors - Michelin, Goodyear, and Firestone - had a lot more money for product, process, and market development. Sure, we could compete with them over the short-term. But over the long-term, they'd grind us down through improvements that we couldn't afford. In that case, bigger was better. But I often wondered: If I'd been, say, the head of Michelin - would it have done me much good to merge with Good- year? I'm not so sure.

It's unhealthy to get too big; when you bulk up, you become bureaucratic and lose the ability to focus. But can a landscape filled with bureaucratic, unfocused megacompanies be a positive development for the world of business? Absolutely - if only because it creates an environment rich with opportunities for companies that are fast, flexible, and focused.

But as a fast company, I wouldn't even try to work with the behemoths. They're too bureaucratic and tough to deal with. Instead, I'd attack them.

Charles B. Ames became associated with Clayton, Dubilier & Rice Inc., an investment firm specializing in management buyouts, in 1987 when he was asked to serve as chairman and CEO of the Uniroyal Goodrich Tire Co. - a portfolio investment of Clayton, Dubilier & Rice Inc. Ames is also chairman of Wesco Distribution Inc., a $2.5 billion electrical-distribution business.

Tim DeMello

Chairman and CEO

Streamline inc.

Westwood, Massachusetts

One of the biggest challenges a fast company faces in this world of merger mania is to leverage the credibility, name, and presence of megacompanies - and to do it without becoming captured by them. In the early stages of our business development, we had no credibility - with the marketplace, with investors, with customers, or with top talent. I learned that how you present your company is crucial. For instance, when talking about Streamline, I could say it is simply a company that delivers a bunch of groceries. Or I could mention how SAP AG, Paine Webber, Intel, and GE Capital have all made investments in us. Does that change anyone's opinion of us?

But fast companies face inherent dangers in the merger dance with behemoths. They've got to walk the line between maintaining their flexibility and making sure that they don't become simply part of a solution for the bigger company. This danger becomes exacerbated when you have several strategic partners at your table. For instance, Paine Webber is one of our investors. But as we look at taking our company public, the question we're asking is, "Who will be the best lead underwriter for us?" What if, for example, we determine that it's not Paine Webber? It's important to stress that reaching strategic agreements with a company in the early stages of your development doesn't necessarily bind you into conducting all of your business with them. A great deal of my time is spent in communicating this principle to our partners.

One thing we've done to safeguard against these conflicts is not taking large investments from any one source. We create a balance among our investors so no one has a dominant position. Sometimes this means we've got to say no to a suitor-investor. For example, EDS approached us about investing in us and creating a strategic relationship. But we didn't feel that a relationship with them would be in alignment with what we were doing. So we passed. That's hard to do. Navigating a strategic relationship is like navigating a minefield. The benefits are tremendous, but so are the dangers - and you've got to manage it carefully.

Before launching Streamline, Tim DeMello (tdemello@streamline.com) was founder and CEO of Replica Corp., an educational game company. Streamline uses the Web to alleviate some of the mundane hassles of life: buying groceries, renting videos, and doing the dry cleaning.

Clive Meanwell

President and CEO

The Medicines Co.

Cambridge, Massachusetts

There are times when big makes sense. Newspapers tell us that megamergers are games played in ego-filled boardrooms by a few people. This explanation is overplayed and underthought. Mergers are not inherently "bad." Whether they work or not, however, generally hinges on the ability of the two management teams to wed their strengths and weaknesses, and to survive their bigness.

What a big company's size can offer in working with fast companies is something like a "docking station" for the product, energy, and passion of the smaller company. About a decade ago, Amgen, a biotech company of a few hundred people, shopped around Neupogen, a very promising drug. A short time before, Amgen had been burned when it hooked up with a behemoth on another product. So the company's top managers were sensitive about who they were going to partner with this time. They ran an auction - the best one I've seen run by any biotech company - in which they nailed every potential buyer to the wall on one issue: commitment. They didn't want to hand over their baby to "the big guys" who would then take it out of their hands to do their magic.

I was at Hoffmann-La Roche at the time. We won the Amgen bid for one reason only: We agreed to wreck every part of our internal operating processes, take them outside, and let Amgen rebuild those processes with us for this global product. The key was that our focal point was the product, not some idea that we were bigger and better and could do as we pleased with what we had bought.

Before founding the Medicines Co., a pharmaceutical investment and development firm, Clive Meanwell (clive.meanwell@themedco.co) was senior vice president of development and operations at Hoffman-La Roche.

Will They Work for Us?

Peter Senge

Chairman

Society for Organizational Learning

Cambridge, Massachusetts

The large, centrally controlled enterprise is a thing of the past. Most of these new big mergers look, smell, and feel like the old-world style. To some degree, they're being driven by the cheap price of capital. This might make a lot of them doable, but that doesn't mean they're sensible. Sure, a group of five people can put two companies together. But can a merged organization of 100,000 people actually work?

There's an inherent problem with size. When innovative small companies start succeeding, they can get big - and risk becoming un-innovative. But not all big companies are lumbering behemoths. So the question is, How do you create really innovative, nimble, fast, big companies?

A good example of big and nimble is Shell Oil. In the early 1990s, U.S. Shell went through a huge financial crisis. But it came out the other side with a commitment to some fundamental rethinking.

In 1994, Shell established a new governance system to shake things up. The company turned its exploration and production divisions - as well as its marketing, distribution, and sales departments into separate businesses. Then it even went so far as to turn all of its internal services - legal, accounting, IT - into separate businesses. Originally, these divisions had been like wards of the state. They had never had to fend for themselves. It was a brutal restructuring process - but it's been so successful that Shell is implementing the new structure worldwide. Here's the point: A crisis made Shell realize that how it was organized as a big company was completely inconsistent with what it cared about.

But let's take a look at the other side: Imagine that bigger is better. What would that big organization look like? Shell is one of the largest corporations in the world. But even as the oil company grows and evolves, it keeps looking more and more like a nimble network.

Peter Senge (psenge@mit.edu) is chairman of the Society for Organizational Learning, a consortium of corporations working together to advance methods and knowledge for building learning organizations. Senge is also the author of the best-seller, The Fifth Discipline: The Art and Practice of the Learning Organization (Doubleday/Currency, 1990).

George Gilder

President

Gilder Technology Group Inc.

Housatonic, Massachusetts

There is a key law to size: The smaller the space, the more the room. The secret of economic growth and creativity is big companies firing people. This releases people from the sealed cells of obsolete bureaucracy and casts them onto the entrepreneurial swells of a new- world economy.

But this trend embeds a paradox: Bigger is still better for the production of most commodities. The entrepreneurial centrifuge continues - impelled by the laws of the microcosm and of the telecosm. Liberation begins with the microcosm: Smaller transistors on slivers of silicon run exponentially faster and cheaper - moving power within companies from the CEO's office to a thousand workbenches.

The rule continues with the telecosm of fiber optics, which moves power outside of companies to customers. The new telecosm will endow one person on an Internet workstation with the communications power of a broadcast tycoon of the television era. In their copper cages, built at a cost of more than a trillion dollars, the leviathan telcos of the world helplessly contemplate the ascendancy of a Qwest or a Qualcomm.

The ultimate goal of microcosm and telecosm is to do more with less, until we can do everything with nothing.

George Gilder (gg@gilder.com) is a respected thinker on technology and public policy. Gilder pioneered the formulation of supply-side economics when he served as chairman of the Lehrman Institute's Economic Roundtable. He is now working on a new book, Telecosm (expected in 1999) about the future of telecommunications.

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