The Merger Endgame Revisited

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1 The Merger Endgame Revisited Ambitious companies drive consolidation in their industries but how? Our Merger Endgame tool sheds light on the best ways to gain long-term growth and reveals strategies for winning the race. 1

2 Growth drives value for companies across all industries, and mergers and acquisitions (M&A) have always been a major strategy for growth. But with a lack of market transparency, investment decisions are made and merger strategies developed with a degree of uncertainty. As a result, growth investments often fall short. A.T. Kearney s Merger Endgame tool reveals strategic ways to win the race to consolidate, creating 360-degree transparency by reflecting industry consolidation patterns, competitive value growth dynamics, and structural breaks. This methodology, which uncovers the challenges and strategies of consolidation stages, is based on a global database of more than 600,000 companies, covering 98 percent of the global market. Applying the Merger Endgame strategy to leading blue-chip companies has helped our clients generate significant returns on their growth investments. The Merger Endgame methodology shows that companies that succeed in the long run proactively drive their industry s consolidation the endgame. But why does it come to this endgame in the first place? The main reason is that companies pursue growth through acquisitions to capture scale advantages. A size advantage lowers costs, which leads to competitive advantage and, often, to competitive price setting. Another reason is that mergers and acquisitions just happen, and industries consolidate over time, although our studies show that 60 percent of M&A fail. 1 For any business, this means either lead the merger endgame and acquire or risk being eaten by a bigger player. And winning hinges on making the right investment and divestment decisions at the right time. The challenge is that these decisions are made with uncertainty, and most M&A integrations do not generate the expected value or capture the projected synergies. Forward-thinking companies have a growth strategy that positions them to win the merger endgame. To develop this strategy, a conceptual framework assesses both historical developments and today s market position and projects scenarios for the future. Companies that succeed in the long run proactively drive their industry s consolidation the endgame. Assessing Historical Developments and Today s Position The Merger Endgame methodology creates transparency, answers questions about an industry s consolidation, and helps define the ideal market position. In theory, industry consolidation can be visualized along an S curve, a good starting point for M&A decision making (see figure 1 on page 3). However, this is a simplified view of the way industries actually evolve. In reality, industries tend to follow unique consolidation paths, and some don t consolidate at all (such as the restaurant industry). 1 Jürgen Rothenbuecher, Joerg Schrottke, To Get Value from a Merger, Grow Sales, Harvard Business Review, May

3 Figure 1 In theory, industry consolidation can be visualized along an S curve Industry concentration (CR3) 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% Railroad Telecom Integrated steel producers Insurance Banks Food retail Diversified chemicals Airlines Utilities Brewers Drugs Confectionery Rubber and tire manufacturers Aluminum producers Integrated oil and gas Shipbuilding Diversified food Automotive manufacturers Automotive Diversified paper suppliers Restaurants and fast food 0% Note: CR3 is the three-firm concentration ratio, the sum of market share of the top three players. Sources: Winning the Merger Endgame by Graeme Deans, Fritz Kroeger, and Stefan Zeisel; A.T. Kearney analysis Defense electrical Distillers Sport shoes Soft drinks Truck and trailer manufacturers Tobacco Time (years) Regardless of the shape of an industry s curve, consolidations tend to develop in five stages (see figure 2 on page 4): Opening. A profitable business opportunity stimulates players to move into a new market (solar in 1998; wind in 2004). Plateau. Once a new industry emerges and new players enter the field, the result is fragmentation. There are many players, but they have no rationale to consolidate (steel from 1990 to 1998; pharmaceuticals since 2002). This is where the app industry is today, with more than 85,000 developers surfacing since the 2007 iphone release. Industries can stay in this stage for many years. Winning the endgame hinges on making the right investment and divestment decisions at the right time. Concentration. The need for scale or global reach pushes strong players to concentrate, either through organic growth or M&A (telco services from 2005 to 2010; breweries from 2004 to 2009; see sidebar: Globalization Pushes Breweries to Merge on page 5). 3

4 Figure 2 In reality, industries consolidate in five recurring phases Concentration (CR3) Today Illustrative ? Time Opening 1 Plateau 2 Concentration 3 Dominance 4 Reopening 5 A profitable business opportunity stimulates players to move into a new market. There are many players with no rationale for consolidation. The need for scale or global reach pushes players to consolidate. There is limited or no need for further consolidation (for example, because of anti-trust or complexity). CR3 declines (for example, because of new technology, new solutions, or new players from emerging countries). Note: CR3 is the three-firm concentration ratio, the sum of market share of the top three players. Source: A.T. Kearney analysis Reopening. The sum of the top three players market share declines because of a new technology or new players, such as those from emerging countries (soft drinks from 2006 to 2009; telco handsets in 2006, when smartphones flooded the market and shifted the power between existing players and rising stars; see sidebar: Technology Trends Push Telco Players Out of the Game on page 6). This stage may be finalized with another M&A consolidation (concentration). Dominance. This is a calm phase, where the need for further consolidation is limited or nonexistent. Reasons include antitrust or industry complexity (search engines from 2007 to 2011; database management systems from 2002 to 2010). When this phase is over, the game could reopen with the growth of emerging market players. Projecting Scenarios for the Future With the Merger Endgame methodology, executives can assess the historical development and current positioning of their industry with variables such as the market share of the top three players. But what will happen tomorrow? Which path will the industry take in the future? What are the implications for business strategies? How fast will it happen? Three drivers can predict the direction of the endgame: Consolidation. Includes reasons such as market cleanup, scale advantages, regional expansion, portfolio expansion, and market entry barriers 4

5 Globalization Pushes Breweries to Merge From 2004 to 2009, the brewery industry was concentrated with an annual growth rate of 12 percent. As markets and brands globalized, scale became a key success factor. At the same time, growth in Western markets stagnated. M&A for breweries provided a strategy to clean up the market, leverage scale advantages, and expand into new growth regions. The top five players Anheuser- Busch, InBev, Kirin, Heineken, and Asahi gained market share through M&A, with a focus on economies of scale and emerging markets (see figure A). Anheuser-Busch grew with a few large M&A, including with InBev in Kirin focused on organic growth in emerging markets. Heineken strengthened its position through smaller M&A, and Asahi kept its market share by focusing on mature markets. Figure A Breweries have been rapidly consolidating Industry concentration (CR3) 20% InBev acquires Quilmes ( 1.0 billion) +12% per year 15% 10% Anheuser-Busch merges with InBev ( 38.4 billion) Kirin acquires Lion Nathan ( 2.8 billion) SABMiller acquires Kompania Piwowarska SA ( 0.9 billion) Market size ( billion) 5% CAGR: 0% Note: CR3 is the three-firm concentration ratio, the sum of market share of the top three players. Sources: Datamonitor 2011, Madsen et al., Aarhus University 2011; interviews; A.T. Kearney analysis Stagnation. Occurs as a result of market stability, barriers to consolidation (such as high share of variable costs), barriers to deconsolidation (industry with dominant or stable market entry barriers and a high cumulated market share of the top three players), dynamic stability, or regulatory constraints Deconsolidation. Arises as a result of market expansion, loss of market entry barriers, competitive challenge, complementary attractiveness, or state intervention Knowledge of the current consolidation stages and predictions about the next phase call for different strategies. Our practical guidelines for the opening stage are straightforward: Define the industry and technology, set standards, build barriers to entry, and, above all, plan well. With a plateau stage ahead, business leaders need to focus on profitability and organic growth, but not at any price, and not while losing sight of merger options. If weak signals indicate a concentration 5

6 Technology Trends Push Telco Players Out of the Game In 2006, new product offerings from new players shifted the market dynamics toward high-end products such as Apple s iphone. Simultaneously, recession boosted sales for new low-end players. Incumbents failed to unveil technological innovations that would meet consumer demands, and the rising new players from emerging markets took their market share (see figure B). This led to an annual decline of 3 percent of the cumulative market share of the top three players from 2006 to Motorola focused too long on its best sellers instead of on innovations and dramatically lost market share. Nokia underestimated the importance of new technology and experimented too long with different software platforms. Samsung adjusted its portfolio based on an in-depth understanding of future customer needs and was fully prepared to hold its own against Apple, the new kid on the block. Figure B Telcos that failed to keep up with handset technology and buyer preferences lost market share Market share 80% 60% Nokia 40% Samsung 20% Apple Motorola 0% Sources: Oppenheimer 2010, Financial Times 2009; interviews; A.T. Kearney analysis scenario, as was the case for breweries in 2004, the focus should be on volume and scale, as Anheuser-Busch InBev and Heineken did with inorganic moves. Another strategy for winning in a concentration stage is to attack or sell in niches, as breweries Kirin and Asahi did with their focus on growth or mature markets. Here, opportunities also exist to cultivate spinoffs or extend global coverage. But the overall strategy needs to refine the existing business model to the new industry challenges. With the outlook of a dominant stage, global acceptance should be cultivated with continual performance and innovation pressure, while simultaneously fighting complexity. When all signs point to a reopening of the industry, as was the case for telco handsets in 2006, competitor intelligence and a warning system are essential. Samsung was one of the few big players to hold on to market share because it reacted quickly to market changes and redefined technology. The lawsuits between Apple and Samsung show how market barriers can also be used to avoid further deconsolidation. 6

7 So how fast do businesses need to react? The main driver of speed is the share of a company s asset intensity. Industries consolidate faster when the share of fixed costs is high (see figure 3). Slow-moving industries are those with few physical assets, such as restaurants, craftsmen, and medical care. Industries moving at a medium speed include automotive, aluminum, and food. Fast-moving industries have the lowest variable costs and high asset intensity, such as software, telecom equipment, and search engines. Figure 3 The higher the share of fixed costs, the faster industries consolidate Speed of industry concentration (CR3 over five years) 9% 8% 7% Beer 6% 5% 4% 3% Express Handsets Operating systems Database management systems 2% 1% Airlines Search engines 0% Chemicals -1% 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50% 55% 60% 65% 70% Note: CR3 is the three-firm concentration ratio, the sum of market share of the top three players (contains estimates). Sources: Thomson Reuters, Capital IQ, Datamonitor, Gartner; A.T. Kearney analysis Share of fixed costs We have shown how to assess the historic development of an industry and project its potential future development. Building on those insights, four different courses of action exist. Figure 4 on page 8 illustrates the options, from driving consolidation (going after first-mover advantage or M&A growth or both) to allowing competitors to drive consolidation (reacting to their game-changing moves). Choosing the best game plan will require a close look to determine the impact of key success factors, map out scenarios, and identify the right strategic options. Following is a case study of how we helped one company shed light on the industry s consolidation status, define its desired position, and create a successful strategy to get there. The company, a global leader of automation and drives, was emerging from a plateau stage characterized by minor consolidations and medium-to-high fragmentation. For the road ahead, most signs pointed toward consolidation and change and only a few toward stability and stagnation. Some major M&A activities had already started, and its businesses were thriving regionally and via expanded portfolios. Price pressures were encouraging standardization and cost optimization. 7

8 Figure 4 Four courses of action can take players to the finish line in the Merger Endgame Yes First-mover advantage Be faster: M&A growth Drive consolidation Opportunity to change the game? Reaction and defense strategy? Divest? No No Let competitors drive consolidation Yes Source: A.T. Kearney analysis A closer look at individual business units revealed that all were in the concentration stage, but some were moving toward a balance stage and others were just starting to consolidate. Each unit s unique growth pattern would require different actions for the company to win the merger endgame. Business unit A was a value grower that needed to focus on sustaining momentum; business unit B was a profit seeker that needed a push to drive for revenue growth; and business unit C, as an underperformer, was at a crossroad: improve or divest. Global acceptance should be cultivated with continual performance and innovation pressure, while simultaneously fighting complexity. Historic growth performance had to be combined with future growth performance to win the merger endgame. Three steps would be vital: Outpace the competition, gain critical size, and attain global coverage. All business units were analyzed for gaps in these steps. In addition, structural breaks were assessed by business unit. Subsegment convergence scenarios that would likely change industry paradigms and China s impact on the business units were also taken into account. 8

9 This led to the following steps for the strategy phase: Develop a China positioning strategy for the three business units. Redirect the three business units: invest or disinvest. Create a new growth strategy for two business units. Based on the assessment, we developed a strategy, defined the growth path, evaluated targets, and consolidated an acquisition program. A competitive analysis of successful value growers showed that combining two business units offered an ideal opportunity, but an acquisition would be needed to gain new capabilities. Targets were filtered in a staged approach to find the best fit, and market interviews were conducted to support the acquisition strategy. The result was a merger endgame map that matched the need with a solution and identified the top candidates. Short-listed candidates were scrutinized, and the growth opportunity was evaluated with variables such as strategic fit, financial impact, risks, and barriers (see figure 5). Figure 5 A Merger Endgame map reveals the best place for mergers and acquisitions Product one Product two Product three North America Europe Asia North America Europe Asia R&D and product portfolio Purchasing and production Sales and marketing Acquisition Solution Need M&A priority Candidates E K J C A F G D B H I Strong position Top candidate Medium position Fallback candidate 1 Weak position Fallback candidate 2 High priority Low priority Sources: Siemens; external interviews; A.T. Kearney analysis 9

10 Two years later, business results showed that the Merger Endgame strategy had supported a profitable growth path. Out of 18 percent business growth, 15 percent came from Merger Endgame projects. What Is Your Winning Strategy? A superior strategy is essential for winning the merger endgame. We recommend considering these questions at the planning stage: What future industry and segment scenarios do you see? What are the benefits of consolidation in your industry or segment? Do you play in a global or regional endgame? Is it better to be a leader, follower, or seller in the endgame? Which competitors are driving the consolidation to endgame? How? What is your defense strategy against competitors potential endgame strategies? How could you achieve a dominant consolidation position? How will you be the winner of the endgame? Global consolidation is a fact of business life in every industry sector. The Merger Endgame and its practical tools can help find the answers to these questions and develop the proactive growth strategy necessary for short-term and long-term success. Authors Jürgen Rothenbuecher, partner, Munich Joerg Schrottke, partner, Munich Sandra Niewiem, principal, Frankfurt 10

11 A.T. Kearney is a global team of forward-thinking partners that delivers immediate impact and growing advantage for its clients. We are passionate problem solvers who excel in collaborating across borders to co-create and realize elegantly simple, practical, and sustainable results. Since 1926, we have been trusted advisors on the most mission-critical issues to the world s leading organizations across all major industries and service sectors. A.T. Kearney has 57 offices located in major business centers across 39 countries. Americas Atlanta Calgary Chicago Dallas Detroit Houston Mexico City New York San Francisco São Paulo Toronto Washington, D.C. Asia Pacific Bangkok Beijing Hong Kong Jakarta Kuala Lumpur Melbourne Mumbai New Delhi Seoul Shanghai Singapore Sydney Tokyo Europe Amsterdam Berlin Brussels Bucharest Budapest Copenhagen Düsseldorf Frankfurt Helsinki Istanbul Kiev Lisbon Ljubljana London Madrid Milan Moscow Munich Oslo Paris Prague Rome Stockholm Stuttgart Vienna Warsaw Zurich Middle East and Africa Abu Dhabi Dubai Johannesburg Manama Riyadh For more information, permission to reprint or translate this work, and all other correspondence, please A.T. Kearney Korea LLC is a separate and independent legal entity operating under the A.T. Kearney name in Korea. 2013, A.T. Kearney, Inc. All rights reserved. The signature of our namesake and founder, Andrew Thomas Kearney, on the cover of this document represents our pledge to live the values he instilled in our firm and uphold his commitment to ensuring essential rightness in all that we do.

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