Which is the most consolidated industry? The answer is remarkable and will surprise many. It is software; for around 40 years now, Microsoft’s Windows (previously DOS) has occupied the hardrive of every personal computer in the world.
There is no rival. There is no upstart about to take its place (at the time of writing). But Windows’ success is as much about consolidation as anything else.
In this article, DealRoom looks at why and when consolidation happens.
There are a few perspectives on consolidation, which we will look at in more detail below:
Motives for Consolidation
The motives for consolidation mirror those for most M&A transactions: Essentially, there has to be a compelling economic motive to combine. This could include:
- Increasing market share: More market share tends to create economies of scale that just aren’t available to smaller players in a market, including increase visibility, increased buying power, and lower customer acquisition costs.
- Increasing buyer power: The ‘economies of scale’ usually referred to in M&A transactions are a common motive for consolidation: A lower cost base generated by a bigger player in the market has the potential for significant revenue generation.
- Synergies: Sometimes – and it is overstated – but sometimes, there are synergies for a deal which enocourge companies to consolidate. This is particularly true in cases of vertical integration.
When does consolidation typically happen?
Consolidation usually happens in fragmented industries, where market participants or investors see that there is significant value to be added from consolidating. This happened in most countries’ banking, pharmacy, and food retail industries, where a small group of three to four players tend to dominate.
Why? Because of the value that can be generated by consolidating in each of these industries.
In banking, for example, banks can easier sell asset management services and mortgages to clients as soon as they’ve acquired them as required customers.
Consequences of Consolidation
Aside from the obvious – companies becoming bigger – there are several consequences of consolidation that tend to routinely occur. These include:
- Market power: Merely by becoming bigger, the companies consolidating have more market power: More ability to influence customer prices, supplier costs, and even the dynamics of markets.
- Reduction of consumer power: Closely related to ‘market power’, the reduction of consumer power (i.e., diminished choice between companies) means that consumer margin is inevitably reduced as a consequence of consolidation. This, and the market power factor mentioned above, both conveniently lead to number three on the list:
- Regulatory intervention: As soon as an industry is deemed to be ‘too consolidated’, it’s typical that a country’s anti-monopoly commission will intervene in the interests of promoting higher levels of industry competition.
The consolidation strategies are:
- Statutory consolidation: Whereby a company is acquired before being completely merged into the acquiring company, with the acquired company being swallowed up by by the acquirer.
- Stock acquisition: Wherein one company acquires another’s stock, but both companies remain in operation beyond the transaction.
- Variable interest equity: Wherein one company acquires a controlling share of another company that isn’t based on having a majority in voting rights.
Stages of industry consolidation
As a general rule, the more consolidated an industry becomes, the more challenging M&A becomes.
That is, as soon as everybody knows that industry consolidation is afoot, the behaviour of the market participants changes – competitors begin competing for the same space, companies sell for higher margins, and the ease with which transactions occur isn’t the same as before.
Broadly speaking, the stages of consolidation are as follows:
- The fragmentation stage: this is the stage of an industry where there are few previous transactions in an industry to justify prices, and a ‘land grab’ is afoot, with early players trying to gain industry powers.
- The acquisition stage: Here, companies have already made several transactions, and the companies they’re looking to acquire have probably already heard of them. The acquirers are likely to have market share percentages of somewhere in the lower teens.
- The expansion stage: Here, the companies looking to consolidate face rivalry from others in the same space who are looking to execute the same strategy. It’s likely that the market share percentages will be somewhere around the 20% mark.
As this article has hinted at, consolidation demands that participants strike a balance between growing and keeping external stakeholders happy.
DealRoom has worked on many transactions in this space and has witnessed this delicate balance.
Suceeding here demands that companies move fast, provide open channels of communication with regulators, and remain focused on due diligence – which can never play second fiddle to regulatory work.
Other factors to consider while navigating consolidation include:
- Value in scale: Is there value in consolidating? Not all industries generate market power purely on the basis of having companies with higher market share.
- Value in pricing: The level of consolidation in an industry will directly impact on acquisition multiples. The multiple demanded by a target has to be measured against how much value its acquisition can generate for the acquirer.
- Likelihood of regulatory intervention: If a company can already reasonably predict that anti-monopoly regulators will be pricked by a transaction, it may be better to avoid the consolidation altogether. Why? Because they might insist that the acquirer’s business is already too big anyway, and needs to be split into several parts.
Conslidation is a reality. It’s everywhere. In fact, the companies that excel in consolidation tend to excel in their industries.
Talk to DealRoom today about how our M&A project management software can help your company navigate the challenges of industry consolidation, avoid the pitfalls, and extract maximum value before the anti-monopoly regular has even heard about it.