In his most recent column, ostensibly about the historically small number of businesses being started, Robert Samuelson opens with a broadside against mergers and acquisitions:
On any given day, you can expect news of major corporate mergers. Last week, we had decisions from FedEx to buy the Dutch delivery company TNT for $4.8 billion and from Royal Dutch Shell to acquire the BG Group, a British natural gas company, for $70 billion. Mergers and acquisitions have become a staple of modern capitalism. In 2014, worldwide M&A totaled $3.5 trillion, up 47 percent from the year before, reports Thomson Reuters.
Now, there are many motives for mergers: to minimize competition; to reduce costs by eliminating overlapping operations; to acquire a hot product or technology (which can be peddled on existing sales platforms); to enter new geographic markets; or to get bigger. Some M&A deals make sound business sense; others suggest managerial empire-building.
But a larger issue transcends individual deals. The popularity of M&A actually involves economic weakness. Unable to expand internally – by creating products or entering new markets – companies rely on M&A for growth.
So let’s talk about mergers and acquisitions. I’m not as interested in global mergers and acquisitions as I am in the U. S. economy. The graph above illustrates the volume and number of mergers and acquisitions in the U. S. by year over the period of the last 15 years. What does it suggest?
First, there’s no simple relationship between volume and number of M&As. The most likely explanation for that is that a greater proportion of M&As are taking place among larger companies. Why might that be? I’ll suggest a few reasons.
- Persistently low interest rates.
- We’re propping up large companies, e.g. auto companies, banks, and leaving smaller companies to fend for themselves. That encourages the formation of ever-larger companies regardless of underlying efficiencies.
- As the role of government spending in the economy increases, that fosters big companies. Big government prefers to do business with big companies.
- As Mr. Samuelson suggests, the sheer volume of government regulations creates efficiencies available to large companies that aren’t available to smaller ones.
I’m sure there are others. In honesty I think the second and third explanation above are more relevant than the last one. Most of the start-ups I’ve known over the years just don’t pay much attention to regulations but that does bring up a point I should have added to my list. Government regulations are a club that big companies use to beat down smaller competitors. A while ago I heard an amusing anecdote that illustrates this.
I was told (remember: this is an anecdote) that in Wisconsin large cheese companies have employees that do nothing all day but drive up and down country roads looking for small dairy farms that are producing cheese (or, worse, raw milk) for sale outside Wisconsin’s highly restrictive state laws and narcing on them. In many states it’s probably harder to get into the food business than it is to get into the drug business. It’s certainly harder to buy raw milk than it is to buy marijuana.
I’d question the underlying assumption that a company ALWAYS must be growing. There’s only so much that people can drink. If you’re in the beverage business, that’s your cap.
Why seek out endless growth at every opportunity? Make your products, sell them for a profit, reinvest when it makes sense & enjoy the remainder.
This reminds me of consulting firm idiocy. Employees get rewarded for bringing in new business, but there’s little or no incentive for retaining the business they have.
When your personal income is tied to stock value it makes all the sense in the world.
Change is the natural order of things. Companies either grow or they shrink. They don’t just stay the same.
About Wisconsin — that wouldn’t surprise me. At one time, it was illegal to sell margarine in the state. Up until recently, it was illegal to serve margarine in restaurants in lieu of butter.
Pretty smart folks if they can tell that a farm is selling cheese or raw milk against the law just from driving by the farm.
Other than banks and car companies, who else is being propped up? According to your theory our car companies should be merging. They are not.
I suggest you follow the money. Who gets rich from the mergers? I suspect it is senior management, not so much workers or shareholders. Don Boudreaux published a nice piece about a year ago showing that while senior management salaries have dramatically increased, when you account for firm size the salary increases are not so outsized. That suggests that senior mgt, knowing that a larger corporation means larger salaries will push for mergers, regardless of other motivations.
Since our govt is basically an insurance company with an army, spending aside from DOD and health care probably does not account for the increase. However, I will certainly buy that they do it to avoid regulations, or create new ones to club small companies. You will be able to much more successfully lobby if you have a billion in revenues instead of a few hundred million.
As there remains no evidence that regulations have increased, certainly their scope has decreased in many areas, I doubt that motivation is much different than it was 20-40 years ago. As it appears that this is a global phenomenon, a global explanation would make more sense to me.
Steve
That’s absurd, steve. There’s a simple, objective measurement of federal regulations: pages of regulations. That increases every year.
There are presently about 175,000 pages in the Code of Federal Regulations. Of that a quarter was added over the last twenty years, 42,000 pages of new regulations. The number of individual regulations is now over 1 million.
Add to that state and local regulations, both of which increase every year.
All four dot points are in play, although in my experience 4 is more important than 3. (As for Steve’s notion, yes, that’s absurd on its face)
When companies can’t reinvest capital productively for growth or efficiency the capital providers want some back. Hence the spate of share buybacks, derisively called financial engineering but really bread and butter, and quite rational. Sometimes rational is growth through M&A. The notion of managements simply buying companies to engineer salary increases is silly, and empire building overwrought. They can get themselves a far bigger pot with share price increases by buybacks or divesting dogs than the arduous task of convincing a board, arranging financing, negotiating and then actually doing something with an acquisition to increase value.
But for those who take on the task, cheap money and sluggish growth in current markets are key considerations.
As we know, many old regulations are left on the books, but not enforced. Many are not even applicable to modern industries. Again, I have never seen a good, meaningful quantification of the number of regulations we now have. But, where we do have an attempt, limited to looking at negative regulations, they do not appear to affect start ups, or what a libertarian economist would call dynamism.
http://marginalrevolution.com/marginalrevolution/2015/02/is-regulation-to-blame-for-the-decline-in-dynamism.html
Steve
Before the ACA, healthcare was probably one of the least regulated sectors of the economy. (I don’t consider government insurance programs to be the same as regulation) As of about two-years ago, there were 10,000 pages implementing it. Source And now come the mergers and acquisitions:
“As the already large pie of health care spending gets larger, competitive players will seek to capture growth through acquisition. Additionally, the aforementioned information technology (IT) costs and costs of regulatory compliance will increase the costs of doing business, such that smaller or less profitable players will be forced to sell. As a telling statistic, a recent survey found that 88 percent of health care executives expect to pursue some sort of M&A activity in 2014.”
Dave: I’m being moderated.
steve: the index of regulatory stringency is poorly constructed. The biggest complaint is frequently “shall” means “may” and vice versa, depending on context. (A person may comply by doing X) A regulatory obligation could be on the state. (If a person requests, the state shall provide the requested information) A single mandatory sentence might be followed by dozens of subparts, but will be weighed as less than a rule written that breaks requirements down into incremental mandates. Frankly, it’s garbage.
If I were to look for something different than page count, I think I would look for some sort of regulatory volition. In my experience, first time regulatory coverage or huge re-writes change business organization practice; whether they decide to get out, expand, or create subsidiaries to better capture income or divert risk. (Are subsidies considered start-ups?)
That increasing regulations in healthcare is promoting larger organizations should be obvious. Sole practitioners are going to work for larger group practices or hospitals. Smaller group practices are going to work for hospitals. The explicit reason for this is regulatory requirements.
Not so obvious, or at least probably not in the way you think. The ACA is cutting Medicare reimbursements. Medicaid will be hurt a bit in states that don’t participate with the expansion. So, small hospitals everywhere are feeling a financial crunch. They don’t have the buying power that large networks have. I have now watched us buy there hospitals that were losing money or barely making it. The cost savings alone from purchasing made them solvent. The larger hospital benefits from increasing its referral population. The smaller hospitals also get access to people from the big places. I now send my Duke, Penn and Emory trained docs to a place that was formerly staffed by grads from places never heard of.
At board meetings and retreats the nationally known experts coming in to talk say everyone needs to get bigger so they will have access to adequate capital. $3 billion in annual revenue is the target. Also, in order to save money many places are contemplating going at risk, i.e. having their own insurance product. Pretty clear why bigger is better for this.
As to individual practitioners, if you follow this issue you know the solo practitioner model has been fading for years. This is mostly due to lifestyle issues. Many small groups are being bought up by larger groups. A lot of this is the PE groups at work or large for profit groups. Again, this started way ahead of the ACA. Groups being bought and controlled by hospitals is largely the result of hospitals wanting a uniform product and the inability/unwillingness of groups to solve problems, plus the ability in some cases to make money off of the billings of the docs. I can cite specific local examples and the ED docs are a very interesting case.
So, the ACA is mostly causing mergers because less money is available. Institutions are merging trying to gain market power. To be fair, EMRs are also probably a factor, but I can’t tell how much.
But, in case I am wrong, which specific regulations are causing these mergers?
Steve
I’m not sure who said it (I suspect it was Dave) but there is a big difference between regulations and regulation.
There are a lot of ways to measure the regulatory burden but IMO compliance cost is the best metric.
steve, does your hospital have a compliance officer?
Nicole. Good point. I will ask her the next time I see her what she thinks.
Steve
When you do keep in mind that twenty years ago your hospital didn’t have a compliance officer.
@steve, I quoted the part about “health care spending gets larger” as a percentage of GDP for the sake of completeness. I don’t think it matters, so long as future business is believed to exist and there is change. If projected increases in IT and information reporting costs cut into profits, consolidation might be able to spread those costs more efficiently.
In 1991, the feds enacted the first broad environmental regulations of municipal solid waste landfills, which set off an M&A spree. The smaller ones would have to close because they couldn’t comply. There was an opportunity for those with resources to buy them either to gain additional facilities or buy their customers for their own facilities. About four nationally-traded companies emerged as the primary buyers (Waste Management, Browning-Ferris Industries, Allied and Republic). And they borrowed so much that their stocks dribbled down to penny-stock territory. My suspicion is that early on, landfill closures brought about by increased regulation were seen as something that would push up prices, but I don’t think it happened that way. Demand softened and remaining landfill space was understated. Of the four businesses mentioned above, only two exist today.
PD- I will mostly buy that, though we need to remember that non-compliance by some of the small planes really meant they were dumping stuff in places they should not. However, that was the sudden onset of new regulations in a specific industry. What we are seeing is more broad based, and international in scope. As much as I know it is convenient to blame the US govt for everything, and by extension the Democrats, I think you need bigger explanations. (Which does not mean regulations have no influence.)
Follow the money remains, I think, the best rule. Or, incentives matter. In the US, management makes more money if their business gets larger. The same holds true in Europe or Asia. Drew always says money matters, except when it doesn’t. Of course, sometimes mergers do provide economies of scale and companies also make more money. Sometimes it gives access to new markets. And, it may be a way to avoid regulations or minimize their impact. That may even be the primary reason for the merger. It still remains that management is the only sure winner. If making more money influences other people, I am sure it also influences senior managements. Look, reverse this. Assume mergers meant better company performance, but it meant management had to take pay cuts. How many mergers happen?
Steve
@steve, “that was the sudden onset of new regulations in a specific industry.” Yes, that was why I commented earlier that regulatory impacts would be most observable with large, initial regulations.
Open dumping has always been illegal under the common law. And before the 1991 regulations, states regulated landfill design and operating standards. What happened in 1991 was federal “overlay” regulations were created. So in some states like Illinois, I would assume no public health benefits, but additional compliance cost and regulatory uncertainty from now having to comply with two programs. In other states, federal law probably completely became the program and environmental standards improved. Federalization means that in a given time period a lot of the same businesses had to make a decision as to whether to close business or invest more, creating a larger pool of buyers and sellers.
BTW/ my comment about healthcare being a relatively unregulated sector had more to do with the notion that medical care remains largely physician-driven — professions either don’t lend themselves to standardized regulations or they simply fight all efforts to define means and methods.