February 7, 2005
by Irwin Stelzer
We have become accustomed to seeing their major industries changing before our very eyes. For investment bankers, these restructurings produce a fee bonanza that sends the prices of New York condominiums soaring, and puts smiles on the faces of Porsche dealers, as thirty-something masters of the universe share their new-found wealth.
The good news is that the investment bankers are not the only beneficiaries of the over-$100 billion in mega-deals that have been done so far this year. Consumers also gain from what that great economist, Joseph Schumpeter, called the gale of creative destruction.
In some instances that gale is unleashed by a change in government policy. The deregulation of the airline industry has resulted in fares so low that consumers who previously couldn't afford to visit grandma for Christmas are now able to complain that they are squeezed into seats shrunken to accommodate the millions for whom air travel is now affordable. The old-line airlines may be bankrupt or headed there as they struggle to find a business model appropriate to an age of competition, but consumers are benefiting from what is a massive transfer of wealth from shareholders and unionized pilots to travelers.
In other instances restructuring is triggered by a combination of changes in government policy and new technologies. The ongoing restructuring of the telecoms industry is the best current example. When the court ordered the dissolution of AT&T's monopoly, separating the long-distance and local calling businesses, the results were lower prices and a variety of new services.
Unfortunately for its shareholders, Ma Bell never did find a way to cope with the competition it faced in the long-distance market. Just as the airlines were burdened with the legacy costs of generous labor contracts, AT&T was handicapped by the high costs of much of the equipment that changing technology had made economically obsolete. And now it will disappear, so weakened that it could not even charge a premium for its shares when it was swallowed up, ironically, by SBC, one of the Baby Bells that was spun off in the original dissolution. Whether SBC's $16 billion acquisition will pay off for its shareholders is unclear. SBC chief financial officer Rick Lindner claims that the combined company will shed 13,000 employees and reap synergies with a net present value of $15 billion, and that the acquisition of AT&T, along with SBC's majority ownership of Cingular, America's largest mobile carrier, will enable it to offer an attractive bundle of services to meet the competition of cable companies.
Perhaps. But much will depend on whether the combined carrier can persuade congress to preserve a regulatory regime that continues to favor incumbents, and whether new, low-cost technologies win consumer acceptance. One thing is clear. The SBC-AT&T reintegration of local and long-distance services has put pressure on other players to form similar combinations. At this writing it is not certain whether long-distance carrier MCI will be taken over by Qwest, a local carrier so weakened by its $17 billion in debt that it has been unable to roll out Internet service in its entire market area, or by another, stronger Baby Bell, Verizon. But one way or another, MCI, established in 1968 as the first competitor to AT&T, will be history soon, marking the end of the independent long-distance business. If the Qwest-MCI deal happens, it would bring together two companies that have managed to lose $80 billion between them since 2000. Meanwhile, Verizon is also considering making a bid for Sprint, which has just agreed to acquire Nextel.
Less visible to most consumers is the major restructuring now underway in the retail sector. Yes, they have noticed the Wal-Mart phenomenon -- the relentless drive by this retailer to lower costs and therefore the prices of everything from t-shirts to trainers to television sets. That has forced competitors to respond either by meeting the lower prices, or upgrading their services, or departing the retail business, as it is rumored Toys R Us might be about to do rather than go head-to-head with Wal-Mart for the little darlings' custom.
And now the pressure of Wal-Mart's cost- and price-cutting is forcing a restructuring of the entire retail sector. First to consolidate were Kmart and Sears, in an $11 billion dollar deal engineered by hedge fund operator Edward Lampert. A Federated-Mays deal may be next. Knowledgeable industry insiders tell me that despite the current disagreement over price, that there is a 50-50 chance that Federated Department Stores will go ahead with its acquisition of May Department Stores, bringing the number one and two department store chains together into a 1,000 store operation with $30 billion in annual sales. Federated has managed some modest gains (3%) in sales by upgrading the merchandise in its Bloomingdale's and Macy's stores, while sales at May's, Filene's, Lord & Taylor, Marshall Field's and other stores have slipped, as has the market share of the entire department-store sector. Proponents of the merger claim that the combined chain would be able to garner some of the cost savings and efficiencies that have catapulted Wal-Mart to it position as the nation's number one retailer. Again, perhaps: the merger might instead divert Federated from its so-far successful strategy of upgrading its merchandise and stores.
The Wal-Mart effect also underlies Procter & Gamble's $57 billion acquisition of Gillette. On the marketing side, the merger will bring together P&G, the premier seller of products to women (Pampers, Tampax, Tide), with Gillette's skills at inducing men continually to upgrade their macho-attractiveness with after-shave lotions and still another generation of razors and blades. But the main force driving the deal is the belief that the bigger company will be in a better position to bargain with Wal-Mart, which has squeezed the margins of its suppliers, and introduced private label products to compete with Tide and other of P&G's major brands. In short, P&G thinks that size and diversification will put it in a better position to contest with Wal-Mart for what one expert, Southern Methodist University's Ed Fox, described to the press as "the ownership of the consumer." Just how that might work is not obvious to the outside observer, since Wal-Mart is unlikely to succumb to a P&G threat to withhold Gillette razors unless it raises the price it pays P&G for Tide.
The net of all of this restructuring seems to be that investment bankers get their fees, and consumers get lower prices and wider choices, so long as competition is not diminished -- something the authorities will have to look at in the case of the telecoms mergers. Since studies have shown that some two-thirds of mergers end up driving down the value of the shares of the acquiring companies, shareholders aren't so lucky. They get a promise of what radical trade unionists in the old days of the IWW derisively dismissed as "pie in the sky in the sweet by-and-by."
A version of this article appeared in The Sunday Times (London).
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.
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