I am confused why large firms acquire smaller firms

(written by lawrence krubner, however indented passages are often quotes). You can contact lawrence at: lawrence@krubner.com, or follow me on Twitter.

It is well known that most mergers are failures. Hundreds of good studies have been written on the subject. And yet large firms continue to acquire smaller firms.

There are other ways that large firms could behave:

1.) A large firm, with mature markets and steady cash flows, act as venture capitalists, funding hundreds of small firms and setting them free

2.) A large firm, with mature markets and steady cash flows, could simply give the money back to investors

So why acquire? Something about growth and expectations? Or defense against future threats? This is the behavior of wannabe monopolists, and the government should step in and fight against this. The economy would be stronger for it. As an example, the USA auto industry would have never gotten itself into crisis (during the 1970s, 1980s and 1990s) if the USA government had broken up General Motors back in 1950. Meanwhile, Japanese auto makers were global terrors when Japan had 8 major auto companies, but now Japan only has 2 major companies, and so they are no longer gaining market share in the USA. Faced with less competition, they are forgetting how to compete.

The Economist has an article on this subject, but they talk about it in almost moral terms, rather than efficiency terms:

Bulking up is a global trend. The annual number of mergers and acquisitions is more than twice what it was in the 1990s. But concentration is at its most worrying in America. The share of GDP generated by America’s 100 biggest companies rose from about 33% in 1994 to 46% in 2013. The five largest banks account for 45% of banking assets, up from 25% in 2000. In the home of the entrepreneur, the number of startups is lower than it has been at any time since the 1970s. More firms are dying than being born. Founders dream of selling their firms to one of the giants rather than of building their own titans.

For many laissez-faire types this is only a temporary problem. Modern technology is lowering barriers to entry; flaccid incumbents will be destroyed by smaller, leaner ones. But the idea that market concentration is self-correcting is more questionable than it once was. Slower growth encourages companies to buy their rivals and squeeze out costs. High-tech companies grow more useful to customers when they attract more users and when they gather ever more data about those users.

The heft of the superstars also reflects their excellence at less productive activities. About 30% of global foreign direct investment (FDI) flows through tax havens; big companies routinely use “transfer pricing” to pretend that profits generated in one part of the world are in fact made in another. The giants also deploy huge armies of lobbyists, bringing the same techniques to Brussels, where 30,000 lobbyists now walk the corridors, that they perfected in Washington, DC. Laws such as Sarbanes-Oxley and Dodd-Frank, to say nothing of America’s tax code, penalise small firms more than large ones.

None of this helps the image of big business. Paying tax seems to be unavoidable for individuals but optional for firms. Rules are unbending for citizens, and up for negotiation when it comes to companies. Nor do profits translate into jobs as once they did. In 1990 the top three carmakers in Detroit had a market capitalisation of $36 billion and 1.2m employees. In 2014 the top three firms in Silicon Valley, with a market capitalisation of over $1 trillion, had only 137,000 employees.

…1917 and all that
The rise of the giants is a reversal of recent history. In the 1980s big companies were on the retreat, as Margaret Thatcher and Ronald Reagan took a wrecking ball to state-protected behemoths such as AT&T and British Leyland. But there are some worrying similarities to a much earlier era. In 1860-1917 the global economy was reshaped by the rise of giant new industries (steel and oil) and revolutionary new technologies (electricity and the combustion engine). These disruptions led to brief bursts of competition followed by prolonged periods of oligopoly. The business titans of that age reinforced their positions by driving their competitors out of business and cultivating close relations with politicians. The backlash that followed helped to destroy the liberal order in much of Europe.

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