turbulence), a few still ranked among the important firms in the year 2000: U.S. Steel, General Electric, AT&T, DuPont, Eastman Kodak, and International Harvester. This merger wave created considerable alarm among editors, scholars, and public officials who weighed the possible benefits of increased efficiency against the evils of monopoly and predatory behavior.
Lamoreaux offers a different story. She found that the bulk of the M&A activity occurred within selected industries—those characterized by capital intensive and mass-production manufacturing processes in which new firms had recently entered with new and more devastating technology. With high fixed costs, these industries faced high operating leverage, and the resulting impulse to cut prices in an effort to maintain market share and, more importantly, volume. This triggered severe price competition during the depression of the mid-1890s.
M&A entrepreneurs entered this turbulent environment to remove older and less efficient excess capacity from the industry through a new form of organization, the trust. J. P. Morgan is a preeminent example of this entrepreneur. He personally led the reorganization of numerous industries, including steel and railroads. Though the newly structured firms successfully removed excess capacity, in the longer run, they proved to be no more efficient than their nontrust rivals, and therefore proved unable to maintain their dominance unless they erected entry barriers. Lamoreaux notes that federal antitrust policy should have been focused on minimizing the erection of barriers, in lieu of offering the “hodge-podge of policies that, as the example of the steel industry indicates, sometimes hindered the combines’ efforts, sometimes helped them.”14 She concludes:
The consolidation movement was the product of a particular conjunction of historical events: the development of capital-intensive, mass-production manufacturing techniques in the late nineteenth century; the extraordinary rapid growth that many capital-intensive industries experienced after 1887; the deep depression that began in 1893…. This conjunction of events gave rise to serious price warfare during the depression of the nineties—price warfare that conventional types of collusion proved incapable of ending. After failing in repeated attempts to halt the decline in prices by means of gentlemen’s agreements, selling agencies, and pools, manufacturers in these and many other industries finally organized consolidations.15
Jensen (1993) applies a similar explanation for the wave of industrial restructuring of the 1980s and early 1990s. He argued that this wave had its roots in the turbulence of the 1970s, with the tenfold increase in energy prices, the emergence of the modern market for corporate control, and an explosion of innovation in the capital markets (specifically the emergence of a high-yield debt market). Most important, however, was the economic recovery that began in 1981 and triggered dramatic technological change, which included innovations that would improve the output of existing assets (e.g., from the rise of the personal computer), and changes that would create obsolescence of older products and processes (e.g., from the rise of Wal-Mart and wholesale clubs that introduced a new retailing model). He also cited the importance of deregulation, globalization of trade, organizational innovation (e.g., through the rise of “virtual firms”) and dramatic political changes (e.g., the decline of the Soviet sphere) as forces of change. The aggregate impact of these changes was a rise in excess capacity in industries. Unfortunately, many firms were slow to adjust: General Motors remained the high-cost producer in the industry and removed its CEO in 1992; IBM was the high-cost producer in mainframe computers until it removed its CEO in 1991. Eastman Kodak changed slowly. General Electric successfully mounted a multiyear internal transformation effort that eliminated a quarter of its total workforce. Jensen called for innovation in organizational design, and applauded the rise of the LBO association as one example through which firms could transform themselves.
Bruce Wasserstein, a prominent M&A adviser, offers another Schumpeterian explanation for M&A activity:
The merger business reflects the hubbub of our society with all its bustling and pretense. It is at the edge of change and fashion, and yet a minefield for the unwary. Mistakes are common. Still, good, bad, or indifferent, mergers and acquisitions are an essential vehicle for corporate change, and the pace of change is increasing. The patterns of industrial development through mergers, like those of economic activity, are crude and imperfect. However, there do seem to be elemental forces, Five Pistons, which drive the merger process. They are regulatory and political reform, technological change, fluctuations in financial markets, the role of leadership, and the tension between scale and focus.16
Wasserstein surveys several industries (energy, conglomerates, financial services, telecommunications, entertainment, and health care) to show that the boom in M&A activity in each of these industries during the 1990s could be traced to the turbulence induced by one or more of the five pistons. Each industry has its own story; one size does not fit all. He concludes:
The specifics driving each deal are different, but there is a common pattern to the process. Existing business strategies and structures ossify over time. These structures may survive for some period with the protection of systemic inertia. Eventually, however, external catalysts give a sharp jolt to the system. Outmoded practices become apparent. Mergers and acquisitions, a kind of rough-hewn evolutionary mechanism, then occur as companies react to the new business realities.17
Schumpeter, Lamoreaux, Jensen, and Wasserstein portray M&A activity as an instrument in the process of industrial renewal, of creative destruction. They present a rich framework for understanding M&A activity that leads to one very practical imperative: Pay attention to economic turbulence, what form it takes, how and which firms it affects, and who exploits it. Mastering an understanding of economic turbulence creates the foundation for many skills in this book: acquisition search, forecasting, valuation, deal design, and postmerger integration.
IMPLEMENTING THE “CREATIVE DESTRUCTION” VIEW: LISTEN TO MARKETS AND FIRMS
When one is conscious of the role of economic turbulence as a driver of M&A activity, one sees the world of M&A more richly. Just like fans follow baseball or music aficionados follow opera, the acute observer of M&A knows what information to look for, and where.
What to Look For: The Many Forms of Economic Turbulence
Interpreting M&A activity and anticipating and structuring deals depends on noticing the presence of the drivers of economic turbulence in a business setting. A consolidated list of such drivers (that expands on those identified by Schumpeter, Lamoreaux, Jensen, and Wasserstein) would include:
Deregulation. The loosening of regulatory requirements in industries such as banking, airlines, trucking, and telecommunications has unleashed a wave of consolidation and rationalization of firms.
Trade liberalization. The lifting of barriers to foreign trade has motivated inefficient protected firms to consolidate with more efficient domestic or foreign firms. The creation of the North American Free Trade Agreement (NAFTA) and the European Union are associated with M&A activity in trade-sensitive industries, such as textiles and agribusiness.
Geopolitical change. The fall of the Iron Curtain triggered a wave of transactions in Central Europe as Western firms sought toehold acquisitions in that new market.
Demographic change. Changes in the makeup of the population can affect competitive strategy and industry structure. Such changes include waves of immigration (in the United States, consumer products firms now compete explicitly for a share of the Hispanic-American market) and aging—for instance, the graying of the population in Japan affects the ability of firms to retain know-how.
Technological change. Advances in all technology-linked industries have prompted firms to seek alliances, joint
