BUYING SHARE, NOT SAND


by Donald V. Potter

In a hostile market, size matters. Companies with larger market shares have additional volume over which to spread costs, making them better able to achieve acceptable returns despite margin pressure.

Share is hard to gain in the best of times, and all but impossible to win away once hostility begins. One practical way to gain significant share during hostility is through acquisition. But an acquisition will be successful only if it brings a significant base of loyal new customers.

Holding On To Loyal Customers

"Acquisition will not change the nature of disloyal customers."

What, after all, is being bought? The goal is to gain share, which means customers. An acquisition will be pointless if customers slip like sand between the fingers.

For the buying company, that means avoiding the acquisition of any competitor whose customers are likely to be disloyal. How does one spot disloyalty before an acquisition? Some companies, through their market positioning, serve volatile customers. The most obvious example would be price shavers, which are suppliers who habitually discount market prices by 2 to 3 percent in order to gain share. They attract the most price-sensitive segments of the market. Their customers are fickle and will quickly bolt to any other supplier offering an incrementally better price. Acquisition will not change the basic nature of those customer relationships.

Other companies may have disenchanted customers likely to become disloyal. This situation often occurs when a supplier has weakened its brand franchise, which can happen even to once-proud competitors as hostility drags on and suppliers make deep, sometimes unwise, cost cuts. Admiral Corporation's acquisition by Magic Chef some years ago offers an example. The appliance industry had been consolidating for 20 years when Magic Chef, a supplier of stoves and ranges, decided to broaden its line and boost its share by acquiring Admiral, which produced primarily refrigerators. By the time Admiral was acquired, however, its brand name had been tarnished and it no longer had a loyal customer base. The acquisition was unsuccessful and in 1986, as consolidation continued, a weakened Magic Chef was in turn acquired by Maytag.

Once an acquisition is made, the buyer must be sure that it does nothing to undermine customer loyalty. If, for example, the acquired company has a strong brand franchise with end-use customers, it may be important to retain the old brand name. Maintaining product quality and service levels is also important. Other suppliers will almost surely attack this newly-enlarged competitor by telling its customers to be on the lookout for deteriorating quality or slipping service. Avoiding those declines is essential to maintaining the customer franchise.

Making the Most of One Plus One

For the acquisition to be worthwhile, it must bring in a substantial net addition of loyal customers. How many customers is the acquirer buying? The answer is not as simple as one plus one. In other words, a supplier cannot expect to add all of the acquired company's customers to all of its own to reach the sum of two.

Some of each company's customers will slip away in the process because customers want to avoid concentrating too much of their volume with a single supplier. Many customers, in fact, have at least three suppliers, each filling a different role. The primary supplier provides most of the customer's volume. A secondary supplier, also with significant share, serves as backup to the primary supplier, offering insurance against product shortfalls or unwarranted price increases from the primary supplier. A tertiary supplier either fills a special product need or, more commonly, offers very low prices that can be used as leverage against the other suppliers in the customer relationship.

Viewed from the customer's perspective, a merger of its key suppliers could pose a risk. To protect itself, that customer would shift some volume to another supplier.

If one plus one won't equal two, how much less will it be? To calculate the potential net new volume of an acquisition, look for overlaps in client relationships or roles. If the acquiring company and the target serve the same customer in different roles – for example, if one is the primary supplier and one is the secondary supplier – their merger will probably mean some share loss with that customer. Volume loss may depend of the roles played with any customer and the customer's size and number of suppliers.

In the glass container industry, when Owens-Illinois acquired Brockway, for example, the combination's original share was 41 percent. It then dropped slightly to 40 percent in four years. Some customers did not feel at risk and were willing to consolidate the OI-Brockway volume. But others, for whom both OI and Brockway had been suppliers, gave some of that volume to other companies in order to see that all their needs for various supplier roles were met.

Closing Thought

A clear understanding of the supplier role needs of the customers of the two combining companies can provide a forewarning of a poor acquisition or guide the higher customer retention of a successful combination.

(Note: This Perspective was written in the context of the economy in 1996. While some of the companies may have changed their policies or indeed no longer exist, the patterns they exhibit still hold today.)


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