GETTING BIGGER, GETTING SMARTER


by Donald V. Potter

In a hostile market, bigger
is better. Nearly always, size is an advantage because the larger company can spread its costs across a greater customer base, lowering unit costs.

During hostility, as we have seen, acquisition is a realistic path to achieving quickly significant share growth. The full value of the acquisition can be achieved, though, only if reductions in cost occur along with market share growth. Unit costs must get smaller as the company gets bigger.

Two Cases of Cost Cutting

The cost-reduction potential of acquisitions in a hostile market can be seen in the examples of Anchor Glass and Delta Airlines.

Anchor Glass Container Corporation built itself up over the years through a series of acquisitions. The company began in 1983 by acquiring the glass container division of the former Anchor Hocking Corporation. Midland Glass Company was added in 1984 and Diamond Bathurst, Inc. in 1987. By then Anchor had become the second largest competitor in the glass container industry. While making acquisitions and adding customers, Anchor also rigorously cut its overhead. The Midland acquisition resulted in a whopping 80 percent reduction in that company's overhead expenses. Between 1982 and 1988, Anchor reduced its sales, general, and administrative expenses as a percent of revenues from eleven percent to only three percent.

Delta AirLines, Inc.'s acquisition of Western Air Lines in 1986 greatly expanded Delta's geographic presence. Delta gained additional ties to the West Coast, including a hub in Salt Lake City and service to 44 additional cities, and its sales rose 20 percent. As part of the deal, Delta agreed to raise Western's salaries to its own higher levels. But this additional salary expense was more than offset by additional sales revenue plus the cost savings made possible when it consolidated the airlines' two hubs in Los Angeles. The overall result was that Delta became the number three domestic airline while its unit cost structure fell notably.

Making the Right Cuts

Cost cutting must be done in the right way and in the right places. The whole point of an acquisition, after all, is to gain share so that costs can be spread over a larger customer base – and that means retaining the loyal customers of the acquired company.

After an acquisition (just as before an acquisition) the key to cutting costs without losing market share is to maintain a tight focus on customers. An acquiring company may need to learn more about the customers of its newly bought competitor. Maintaining customers' loyalty requires knowing what they value and what shapes their buying decisions, so that information can be used to:

  1. Protect the features and benefits that matter. Make no cuts that will upset or dissatisfy customers and tempt them to shop around. If customers value a brand name, for example, maintaining that brand may be worth more in customer loyalty than the costs saved through eliminating it. Some product features or services may also be more important than others in retaining customers.

  2. Cut all costs that the customers won't see. Overlapping staffs (such as at Anchor and Midland) and redundant operations (such as the Delta and Western hubs at LA) can be cut. Any other aspect of operations not closely tied to delivering the features and benefits customers value can also be cut.

Cutting Deeply Enough

Cost cutting must also be undertaken with sufficient ambition. When an acquisition fails to achieve its cost reduction potential, it is most often because management did not focus on unit cost reduction.

During the mid-1980's wave of consolidation in the food industry, Phillip Morris bought General Foods and Nestle bought Carnation. A few years later, the Nestle deal looked far better as Carnation's unit costs dropped with Nestle's strict bottom-line focus on cost control and growth. General Foods, without similar parent attention, lagged in profit growth.

Cost cutting needs ambitious targets. Selling, general, and administrative unit costs in many industries grow at only three quarters of the rate of unit sales volume growth. The overhead structure resulting from the combination of two companies should not be greater than that structure would have been if either company had grown, rather than merged, to its combined company size.

Closing Thought

An acquisition cannot be successful if it is not profitable. Profitability requires that the combined company see sales share growth and cost share shrinkage. Retention of customers and ambitious unit cost reduction targets are both essential to bigger sales and smaller costs – in other words, more profit.

(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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