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Merger Endgames

Industry
CONSOLIDATION
and Long-Term
STRATEGY
Introduction
The pace of mergers has reached dizzying heightsand shows no sign of subsiding in the foreseeable
future. In one industry after another a new round of consolidation begins, touching off the next
flurry of restructuring. Yet, A.T. Kearney research shows that 56 percent of mergers do not succeed,
failing to produce shareholder value. This result, unsurprisingly, draws media attention rivaling that
devoted to the spate of marriages. From local to trade to business press, articles have chronicled a
slew of divorces. Among the most recent: AT&Ts announcement to break itself up into four stand-
alone entities (wireless, broadband, business and consumer) and British Telecoms decision to sep-
arate its U.K. fixed-line business into wholesale and retail segments.

Thus the headlines changefrom talk of mergers one day to divestitures the next. The logic behind
the change in activity can be difficult to discern. Does the urge to merge change with the wind?
Do mergers and breakups occur by chance? Are alliances unpredictable, random phenomena?

It would appear that chaos reigns in the world of mergers and acquisitions. But our analysis reveals
that these trends are not a matter of happenstance. On the contrary, when we take a deeper look, it
becomes evident that industry consolidation conforms to a set of laws. In this paper, we will look at
the patterns that emerged in our research and show where several industries lie on the consolidation
curve. Companies that understand where their industries lie on the curveand develop strategies
based on that knowledgewill position themselves to win.

Merger Endgames


Regardless of industry, consolidation activity follows a distinct pattern, according to a study
conducted by A.T. Kearney. It progresses through four phases of different lengths. In addition,
the number of mergers varies in reverse proportion to the extent of consolidation.
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:
Opening Focus
Accumulation 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 1030 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 (see figure 2).
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

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Merger Endgames

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 Tlcom and Tlefonica
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.
Tlefonicas 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 DeutscheTelekom and
Mobilcom. After roaring off to a fast start in the liberalized European market, the latter is now
encountering growing difficulties. Mobilcoms partner France Tlcom 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 3045 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 (see figure 3). Mergers and acquisitions are part of the industrys 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 manu-
facturers 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

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Merger Endgames

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 com-
panies 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 companys 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 (see figure 4).
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 industryleaving 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 Seagrams 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 Seagrams
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.

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Merger Endgames

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 particu-
larly 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 7080 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 5).
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 sur-
prising parallel to the movement of stock indexes. The Dow Jones Industrial Average moves in
tandem with mergers and acquisitions (see figure 6).

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Merger Endgames

Merger activities are highly dependent on stock movements. Rising stocks provide companies
with considerable acquisition currency. In addition, growing globalization and massive dereg-
ulation 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 Internets 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 accordinglyand emerge as winners.

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Merger Endgames

Figure 1: The four stages of consolidation




100%
0.7
90% Defense Electr.
Cigarettes
Automation Controls
80%
Maximum
Distillers
70% Shipbuilders Shoe Mfrs.

Mil. & Comm. Aircraft Mfrs.


60% Turbine Mfrs. Soft drinks

Truck & Trailer Mfrs.


Confectionary 0.1
50% Games & Toys
45% Rubber & Tire Mfrs.
Divers. Food
40% Apparel Store Chains Automotive Mfrs.
Breweries Steel Producers
Railroads Logistics
30% Chemicals Restaurants & Fast Food
Telecom
Drugs Regional Food Stores, Department Store Chains
Airlines Automotive
20% Suppliers
Minimum
Utilities
10% Insurance Banks Retailers 0.01

0% 0
-5 0 5 10 15 20

1
CR3 = Market share of the three largest enterprises relative to the overall market of VBG database
2
HHI = Logarithmic scale
Source: VBG database, A.T. Kearney analysis

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Merger Endgames

Figure 2: Global telecom industry growth portfolio (CAGR 19952000)


140%
QWEST

105% WORLD ACCESS

CENTURYTEL NEXTEL
WINSTAR COMMUNICATIONS
TOTAL-TEL
DAVEL COMMUNICATIONS
85% US CELLULAR
HUNGARIAN TELEPHONE

TELEFONOS DE MEXICO CENTENNIAL COMMUNICATIONS WORLDCOM


POWERTEL
ARCH
GRUPO IUSACELL
QUEBECTEL PANAMSAT
65% CANADIAN SATELLITE COMMUNICATIONS
ROGERS CANTEL MOBILE
PHILIPPINE TELEPHONE
SHIN SATELLITE METROCALL VODAFONE
TELEFONICA DE ARGENTINA
T-NETIX HICKORY TECH SBC CHINA MOBILE

45% CONESTOGA
ICG
Industry Average (17%)

TELEKOM CHILE
TOTAL ACCESS
KOKUSAI DENSHIN DENWA
CALL-NET
TELECOMASIA VERIZON

25% GENERAL
CENTRAL COSTANERA DDI
TELEKOM MALAYSIA ALLTEL
C&W
TELEKOM PERU BT
PAGING NETWORK D&E TELEFONICA
CFW SONERA
TELULAR NORTH
5% THAI TELEKOM
UNITED COMM.
BELLSOUTH
TELIA TELECOM TELSTRA
SINGAPORE TELEKOM ITALIA
TELEX-CHILE FRANCE TELECOM
AT&T DEUTSCHE
SWISSCOM TELECOM
PILTEL KPN

-15% PERSEROAN INDO SATELLITE TELE DANMARK


BCE
CITIZENS COMMUNICATIONS BROADWING
EQUALNET ISRAEL TELECOM SPRINT
NTT
TELEKOM INDONESIA BRASIL TELECOM JAPAN TELECOM
TELECOM NEW ZEALAND COMSAT PORTUGAL TELECOM
ATLANTIC TELE-NETWORK COMMONWEALTH TELEPHONE
-35%
-50% 0% 50% 100%

Market capitalization Industry Average (42%)


Value and sales growth each between 9599; market capitalization as of Nov. 2000
Qwest value growth 9799, sales growth 9799; Telstra value growth 9899, Deutsche Telekom 9899,
France Telecom 9799; for Telia and Sonera EBIT growth was applied as a gauge for value growth, sales growth 9899;
Mobilcom bought by France Telecom Source: VBG Database

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Merger Endgames

Figure 3: Global automotive supplier growth portfolio (CAGR 19952000)


HAYES LEMMERZ
KEIHIN
HALDEX
35% MAYFLOWER

DONNELLY
ABC-NACO
BORGWARNER
MAGNA MGI COUTIER POULLAIN
COLLINS & AIKMAN
KOITO LEAR GRAMMER

25% FUTABA
SHIROKI
SAI BREMBO SPA
ARVIN
SPX
WOODWARD
SHOWA
NISSIN KOGYO Brose SIMPSON
PACIFICA
Industry Average (10%)

TOPRE
JOHNSON
DELCO REMY

15% BRIDGESTONE
FAURECIA VALEO
DANA
BBA
TOYODA BOSHOKU
DENSO
CALSONIC KANSEI
CONTINENTAL
MITSUBA NIPPON SEIKI
5% NISSAN SHATAI
AISIN
SEIKI LABINAL
MONTUPET SA
TOYODA GOSEI

AISAN EXEDY WYNNS MAGNETI MARELLI


PACIFIC
FUJI UNIVANCE MASCOTECH
FUJI KIKO NISHIKAWA
KINUGAWA RUBBER EXIDE STANLEY ELECTRIC
TOYO RADIATOR
BBS KRAFTFAHRZEUGTECHNIK AG STANDARD PRODUCTS
JIDOSHA DENKI KOGYO

-5% NABCO
NIPPON PISTON RING
DELPHI
NGK SPARK PLUG
SOGEFI
RIKEN MARK IV
UNISIA JECS MODINE STANDARD MOTOR
TITAN
PRESS KOGYO KIEKERT DETROIT DIESEL
JASON TOKAI RIKA
HASHIMOTO BOSCH
ASAHI TEC
SANOH INDUSTRIAL CO., LTD.

PERUSAHAAN OTOMOBIL TOYODA MACHINE


-15% MICHELIN
GOODYEAR
VISTEON

TENNECO AG KUEHNLE, KOPP & KAUSCH

-25%
-60% -40% -20% 0% 20% 40% 60% 80%

Market capitalization Industry Average (3%)


Value and sales growth in each case from 9599; market capitalization as of Nov. 2000;
missing MC data was determined by MC/Rev multiples; Delphi Rev. 9699, Nissan Shatai AMC 9699
Source: VBG database, A.T. Kearney analysis

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Merger Endgames

Figure 4: Global distillers growth portfolio (CAGR 19952000)


40%

30% DIAGEO
Industry Average (13%)

20% JEAN-CLAUDE BOISSET

VINA CONCHA Y TORO

BROWN-FORMAN

10% BRL HARDY


GLENMORANGIE H.P. BULMER SEAGRAM
LA TONDENA DISTILLERS ZWACK UNICUM

GODO SHUSEI
TODHUNTER
0% TAKARA SHUZO

PERNOD RICARD
NIKKA WHISKY DISTILLING STELLENBOSCH FARMERS WINERY

BODEGAS Y BEBIDAS
BERENTZEN-GRUPPE

-10%
MARIE BRIZARD ET ROGER

REMY COINTREAU
ALLIED DOMECQ
-20%

-30%

-50% -40% -30% -20% -10% 0% 10% 20% 30% 40% 50%

Market capitalization Industry Average (17%)


Value and Revenue growth 9599, market capitalization of Nov. 2000; Pernod-Ricards main business (approx. 60%) is non-alcoholic drinks
Source: VBG database, A.T. Kearney analysis

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Merger Endgames

Figure 5: Global shoe industry growth portfolio (CAGR 19952000)



40%

YUE YUEN

30% ADIDAS-SALOMON
Industry Average (16%)

COLE

VANS

20%
POU CHEN
ROCKY SHOES & BOOTS
NIKE
WOLVERINE LAMBERT HOWARTH
SAUCONY
10% MAXWELL SHOE
AIGLE TIMBERLAND
LACROSSE FOOTWEAR
WELLCO
BATA INDIA
DECKERS OUTDOOR PUMA
WEYCO

0% BARRY ASICS

SECAICHO
MIZUNO FLORSHEIM
SALAMANDER
P.T. SEPATU BATA STEPHANE KELIAN
REEBOK

-10%
CONVERSE

-20%

-30%
-40% -20% 0% 20% 40% 60%

Market capitalization Industry Average (10%)


Value and Revenue growth 9599, market capitalisation of Nov. 2000; some companies have substantial parts of their business in other industries
Source: VBG database, A.T. Kearney analysis

Figure 6: The parallel between mergers and stocks

12,000

10,000

8,000
Dow Jones
6,000

4,000
Increasing Trend
(+8.4% CAGR)
2,000
Number of M&As Worldwide
0
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

Source: Mergerstat

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