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Does size matter?

It is London Fashion Week, but rather than talk about the tiresome business of fashion - whose value is hugely exaggerated by business journalists who desperately want to talk about something sexy - it is an appropriate time to take stock of the current business vogue: merger.

In the very week that the biggest merger of all time - SmithKline Beecham Glaxo Wellcome Uncle Tom Cobbley and all - collapsed, the world's stock markets powered ahead on hopes that new mergers would follow.

In London, of course, prices were fuelled by the marriage of General Accident and Commercial Union, although the two companies themselves were among the worst performing stocks in the FTSE 100 after their announcement.

Ironically, though, while markets frothed over the prospects for mergers, Courtaulds' shares rose by 20% on the announcement that the company was to break itself up, splitting polymers, coatings and fibres into their own parts.

What makes a merger a Good Thing?

It is pretty obvious that something funny is going on. Are we feeling up about merger? Or down about it? Or plain confused?

The answer is, in fact, not that difficult.

Markets are feeling up about mergers and down about conglomerates. They now like it when companies in the same business get together, but are equally happy when disparate businesses all bundled together into one unmanageable corporation are demerged.

Whereas in the 1980s, merger activity was often motivated by a sense that good management (eg Hanson) could usefully take any business over and run it well, in the 1990s, merger is motivated by a sense of synergy and economy of scale.

The idea is that to get efficiency savings out of a merger, there have to be costs that are common to both participants. And for there to be common costs, firms have to be doing more or less similar things.

Large accounting firms, large pharmaceutical companies, large investment banks and insurance companies, large high street supermarkets, large book and record retailing chains - the idea is that these horizontal mergers should allow the companies involved to achieve lower costs than smaller scale rivals. Firms trying to make anything from batteries to bricks can achieve none of the same benefits.

So are the markets right in their perception that these mergers are 'value enhancing'?

The lessons of history

The first worry is that in the past, the markets have generally got it wrong. The merger wave of the 1960s (creating British Leyland) and the 1980s had no discernibly positive effect on the UK economy whatsoever.

Indeed, a lot of the recent merger activity is imply undoing the mergers of years past. For example, Somerfield's merger with KwikSave, announced this week, simply reflects the weak position of Somerfield after its disastrous buy-out by Iscosles in the early 1990s.

Everything is relative

The second worry is that even if each giant merger fails to generate large synergistic gains, it makes life scary for smaller rivals, who then themselves feel pressured to engage in merger. The merger wave thus generates its own nonsensical momentum, in which companies leapfrog over each other to avoid being left as a small fry in an industry of elephants. As a result, the elephants get larger and larger.

This really could describe the merger process going on at the moment, particularly if it is not so much one's size that matters, but ones relative size.

If life is easier for the biggest company in an industry, not just because it is big, but because it is bigger than anyone else - maybe it has more consumer recognition for example, or more price-setting power over rivals - then everybody wants to be biggest.

This the case even if there are no real benefits to the industry from being populated by big firms as opposed to smaller ones. There does appear to be something in this argument.

Size of ego can be too important

The third and most significant worry is that the motive for merger has less to do with the neat corporate logic of MBA students, and more to do with the egos of company executives who want to add the exhilarating thrill of deal-making to their working lives and build larger and larger empires.

Quite why the markets would be duped by this, is unclear, but there must be a worry that this account explains what is going on.

Take the failed SmithKline-Glaxo merger. Having explained to us that it was worth billions of pounds, the management of the companies let it fail on account of apparent differences over the roles of the senior executives. That is not an inspiring explanation.

Either the merger was worth very little, or the directors have failed in their responsibility to manage the companies well, by declining to merge on account of their own personal interest.

Time to reflect

In all, these worries should concern shareholders and governments alike.

We know that mergers are subject to fashion, we know they have a chequered past. We also know that when all else fails, the creation of larger companies tends to result in more monopoly, less competition, and higher prices.

It is probably time for the markets to see the soaring bid speculation and consequent effect on share prices so evident at the moment as a temporary bubble, rather than as a real enhancement of value in the UK corporate sector.

Relevant Stories

Insurance giants in £15bn merger (25 Feb 98 | Business)
Mergers a 'threat to customers' (25 Feb 98 | Business)
Failed merger triggers shares wipeout (24 Feb 98 | Business)
Drug giants scrap merger (24 Feb 98 | Business)
Supermarkets walk down the aisle (19 Feb 98 | Business)
Union opposes reported bank merger (16 Feb 98 | Business)
Accountancy merger off (13 Feb 98 | Business)

Internet Links

Somerfield
Glaxo Wellcome
SmithKline Beecham
KPMG
Ernst & Young
General Accident
Commercial Union

The BBC is not responsible for the content of external internet sites.

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