September 12, 1999
Paradox of the Internet Era:
Behemoths in a Jack-Be-Nimble
Economy
By STEVE LOHR
In
the modern Internet economy, the race of
capitalism
belongs to the fleet and nimble. The
preferred organizational
model, it seems, is the Silicon
Valley start-up -- informal,
entrepreneurial and
youthful.
"Three people, under 25,
with a hot idea -- those are
the companies we're backing,"
explained Ron Conway,
who heads a start-up investment
fund in Silicon Valley.
Yet across much of the corporate
America the ethos of
"bigger is better" is flourishing
-- and last week's
announcement that Viacom
Inc. agreed to buy the CBS
Corporation for $37.3 billion
is merely further
confirmation of the recent
trend.
The five biggest merger deals
ever came last year,
when the total value of
corporate acquisition activity
reached a record $1.6 trillion,
equal to 19 percent of
the annual output of the
economy. So far this year,
reports Thomson Financial
Securities Data, a research
firm, the mergers total
$1.06 trillion, only slightly
behind the 1998 pace. Business
deals on this scale have
not occurred since the turn-of-the-century
days of J. P.
Morgan and John D. Rockefeller.
The forces behind many of
the big deals are rapid
technological change, deregulation
and freer trade,
which make it more efficient
to market products and
manage operations globally.
The booming stock
markets have fueled the
merger binge because most of
the corporate purchases
are made with shares instead
of cash.
Such mergers seem to pass
the logic of a high-school
economics course. They are
intended to expand a
network for the distribution
of goods or services or
consolidate overlapping
networks. The goal is to more
efficiently use a high-fixed-cost
network -- whether that
network distributes phone
calls, banking services or
gasoline.
Yet the logic behind many
deals is tricky to explain --
and ego, hubris and management
fads are often part of
the motivation. Over the
years, research on mergers has
found that many fail, as
post-deal returns for
shareholders often trail
the market averages. Putting
together two large organizations
is a difficult
management challenge, business
analysts say, even
when the two companies are
a good fit strategically.
"The companies are so large
in most of these deals that
they already have all the
sins of bureaucracy,"
observed Rosabeth Moss Kanter,
a professor at the
Harvard business school.
"Some of the merger activity
we're seeing is defensive
strategy in times of rapid
technological change and
uncertainty. It's an attitude
that we'll link up with
another company before someone
else does."
Merger deals are always oversold
when they are
announced. A helping of
hyperbole is expected, but
certain arguments are particularly
suspect, business
experts warn. Deals are
often presented as a "merger of
equals," an ego-stroking
euphemism intended for the
ears of the chief executive
and staff of the acquired
company. "The merger of
equals is a myth," Ms. Kanter
said. "Show me one."
Another suspect assertion
is that a big merger will
result in the new economic
math of synergy -- a term
that first gained currency
during the wave of
conglomerate mergers in
the 1960's, a business fad that
in hindsight appears to
have been folly. But today's
executives still sometimes
play the synergy card when
justifying a deal, saying
that "one plus one will equal
three" or "two plus two
will equal five."
The hoped-for synergy rarely
materializes. "Most of the
time, it's two plus two
equals three," said Michael
Cusumano, a professor at
the Massachusetts Institute of
Technology's Sloan School
of Management.
The modern synergy strategy
usually involves putting
together two companies in
related fields, and then
trying to cross-promote
the offerings of each. An
example is Travelers Group's
purchase last year of
Citicorp for nearly $73
billion, assembling a financial
services empire that includes
insurance, commercial
banking, investment banking
and a stock broker.
The "financial supermarket"
is a catchy phrase, but it is
not yet proved to be a winning
business strategy,
industry analysts say. A
notable failure is Sears,
Roebuck's venture into financial
services, which it
abandoned in the early 1990's.
The big media mergers are
partly inspired by visions of
the payoff from combining
related businesses. Michael
Eisner talked a lot about
synergy when Disney acquired
Capital Cities/ABC in 1995.
And the Viacom's planned
purchase of CBS is similar.
Both deals link
entertainment studios with
television networks for
distributing that programming
to the households of
viewers. Yet the Disney-Capital
Cities/ABC merger
has proved to be a disappointment
so far, most industry
analysts agree, and the
Viacom-CBS merger faces some
of the same challenges.
The business strategy,
it seems, runs counter to some
basic free-market principles. Isn't the producer of
entertainment programming
better off having several
networks bid for his programs?
And isn't a television
network better off being
able to choose among
competing suppliers of programs?
Is becoming a much bigger
corporation a stimulus to
creativity -- vital to the
entertainment business -- or a
hindrance to it?
"The challenge for the big
combined media companies
like Disney, Time Warner
and now Viacom is how to
make these very large corporations
with complex sets
of relationships work in
ways that pay off," said David
Nadler, chairman of the
Delta Consulting Group Inc., a
management consulting firm.
"Just owning a bundle of
different properties doesn't
mean you get the
profit-making synergies
that executives talk about when
they announce these mergers."
B IG companies, to be
sure, can succeed in being
creative, even
entrepreneurial, if organized
and managed properly.
The Microsoft Corporation,
for example, has become a
huge company, but it keeps
its software programmers
working in modular teams
of three to eight people.
Perhaps the leading big-company
success story, though,
is the revival of the International
Business Machines
Corporation under Louis
V. Gerstner Jr. When he took
over the stumbling computer
maker in 1993, Mr.
Gerstner was widely expected
to turn the
bigger-is-better rationale
on its head, breaking up
I.B.M. into a group of smaller
companies, which, it was
assumed, could better keep
pace in fast-changing
technology markets.
Instead, Mr. Gerstner kept
the company together. He
decided I.B.M.'s huge investment
in research and
development was an underused
asset that could be
spread profitably across
the company's many computer
divisions. And he streamlined
management, slashed
bureaucracy and built up
I.B.M.'s faster-growing
services and software businesses.
The results have been impressive,
as profits and
I.B.M.'s stock price have
rebounded. The laudatory
reviews extend well beyond
Wall Street. The
Washington Monthly recently
published an article,
"What Lou Gerstner Could
Teach Bill Clinton: Lessons
for Government from I.B.M.'s
Dramatic Turnaround."
Even those Silicon Valley
start-ups, of course, are
eager to get bigger, and
the hopes of many involve
mergers. Microsoft and America
Online, for example,
are frequent buyers of other
companies. With the
exception of America Online's
multibillion-dollar
purchase of Netscape last
year, most of the Microsoft
and America Online deals
are smaller purchases, up to
a few hundred million dollars,
of promising start-ups
that have begun to take
off.
The new economy may favor
the nimble, but a paradox
is clear.
"The dream of those three-person
Internet start-ups is to
grow to a 100-person company
and get bought out,"
observed Eric Greenberg,
director of management
studies at the American
Management Association.