Merger mania: legal and strategic response options for small business.

Geiger, Joseph ; Wegman, Jerry

ABSTRACT

Merger mania is once again gripping our nation. The merger trend is slated to continue because of a combination of emerging information technologies, deregulation, privatization, and lowered trade barriers. The implication for small business is significant: when competitors consolidate, the small business is more vulnerable to the strong arm tactics available to these larger competitors. Some of those tactics are illegal, but large competitors might violate the law, either willfully or unknowingly. It is the responsibility of small business to be vigilant in knowing its rights in this area and enforcing them.

This paper will present the legal and strategic response options of a small business when faced with a merger that will create a new dominant firm. The history and rules of merger law will be described; legal response options, then strategic response options will be discussed; finally a recent case in which a small business was confronted by this problem will be reported and used to illustrate various response options.

INTRODUCTION

Imagine that you are a small business owner. After years of hard work you have achieved a market share of 20% of your niche market. One day, as you read your monthly trade journal, you learn that your two largest competitors have announced a merger. The new firm will become dominant in the market, with about 70% of sales. Past aggressive business tactics of the merging firms raises your concern that the newly dominant firm will throw its weight around. Will you be able to compete effectively in the new environment? Is the merger legal? What can you do to challenge its legality or respond strategically to this new threat? This paper will address these concerns.

LEGAL HISTORY

As long ago as 1911, President William Howard Taft recognized that monopolies and concentrated industries are a threat not only to the public, but to small business as well (Schnitzer, 1978). The antitrust laws were enacted to counter that threat. The first federal antitrust statute was the Sherman Act of 1890. It made it a federal crime for a firm to either monopolize an industry or to act in concert with other firms to restrain trade. However, federal prosecutors found it difficult to enforce this act, and in 1914 Congress attempted to strengthen enforcement by enacting the Clayton Act. This act made certain specific actions, like price fixing, automatic violations of the Sherman Act. It also make it illegal for firms to merge if there was a reasonable likelihood that the merger would result in less competition. This was an important change, because the Clayton Act's anti-merger provision did not require proof of actual harm, only proof that harm "may" result. This lighter burden of proof made it easier for federal regulators to prevent a proposed merger, compared with attempting to break up an existing monopoly (Cheeseman, 1998).

From the point of view of small business, however, there has always been one major problem: while the antitrust laws authorize the federal government to act, they do not require it to act. Enforcement is discretionary. It is a matter of policy, ultimately set by the president. And different presidents have had varying attitudes towards antitrust enforcement. A president who is sensitive to the campaign contributions of big business, and who wishes to curry favor with Wall Street, will not be a vigorous enforcer of antitrust laws. A small business owner does however have an option aside from attempting to persuade regulators to do their duty: it can bring a private lawsuit to block a merger or it can sue for damages sustained by anti-competitive practices (Dunfee & Gibson, 1985). However, these lawsuits are expensive. They require specialized legal talent and expensive expert witness testimony. They involve difficult application of imprecise statutory language, so appeals are likely. By the time the appeal process is complete years may have passed, and the small business plaintiff may have ceased to exist.

WHEN ARE MERGERS ILLEGAL?

A merger will be declared illegal when a court determines that the merged firm may have a degree of market power in a certain product market. Market power is inferred from a high concentration of market share. Before market share can be assessed however it is first necessary to determine what the "relevant product market" is (Gellhorn, 1981). For example, in the famous DuPont cellophane case (1956), the court was required to determine whether the relevant product was cellophane or all flexible package wrappers, including tinfoil and paper wrappers. Dupont controlled 75% of the cellophane market, but only 20% of the larger flexible package wrapper market. The court decided that the relevant product market in that case was cellophane, because the other package wrappers were not acceptable substitutes in many applications.

Once the relevant product market has been determined, the court will turn its attention to the "relevant geographic market". Consider for example towns A and B that are 5 miles apart, each with ten movie theatres. If one firm owns nine theatres is town A, and none in town B, then that firm has market share of 90% if the relevant geographic market is town A only. But if the relevant geographic market is both towns, that same firm has market share of only 45%. The courts will decide the size of the relevant geographic market based on the distance that consumers are willing to travel to obtain the product. In this example, most consumers are willing to drive 5 miles to see a movie, so the relevant geographic market is both towns.

After determining the relevant product market and the relevant geographic market, the court will determine the market share of the merged firm. If the number is high, market power will be inferred and the merger will be blocked by the court. How high is high? The Antitrust Division and FTC have issued Guidelines that state that a market share of 35% or more will imply market power, in many cases (U.S. Dept. of Justice and FTC, 1998).

LEGAL RESPONSE OPTIONS FOR SMALL BUSINESS

Small business has six legal response options when threatened by market dominance of a newly merged firm. These are: (A) hire an attorney; (B) persuade the government to block the merger; (C) threaten to sue; (D) bring a multiple party lawsuit against the offender; (E) bring a private lawsuit against the offender; (F) sell out to the newly dominant firm.

STRATEGIC MANAGEMENT RESPONSE OPTIONS FOR SMALL BUSINESS

There is considerable literature on the subject of strategies for firms (large and small) which are suddenly in a weakened competitive position. However, studies (Chen & Hambrick, 1995) have shown that low market share firms can be as effective as their high share competitors. The key is to develop and quickly implement a package of strategies and tactics without injuring long term performance (Chen & Hambrick, 1995).

When consolidations occur in heretofore fragmented markets (such as the Whitewater Kayak example), the surviving firms must quickly employ both short and long-term initiatives in order to minimize the negative effect consolidation may have on their competitive position. This section of the paper builds upon the work of four leading authors of strategy, Thompson and Strickland (1998) and Hill and Jones (1998).

Depending on the nature of the market (industry segment), responses can be categorized into three groups: (1) Becoming bigger yourself, (2) Creative counter-punching, and (3) Attacking rather than becoming defensive.

Becoming A Bigger Player

This strategy can be realized by (1) merging with one or more surviving firms, (2) changing current corporate strategy and increasing size by creating a chain store organization, (3) growing by converting the firm to a franchise operation and selling franchises throughout the marketing region, and (4) developing strategic alliances for supplying existing chains and/or franchises.

These "bigger player" strategies attempt to replicate what the 'sudden consolidators' move to create--a new, large competitor capable of exploiting all the advantages of size: market penetration, national brand image, and economies of scale throughout the value chain such as in advertising, marketing, production, and purchasing.

Creative Counter Punching

This strategy is focused upon determining and implementing several specific activities each designed to focus on competitors' weaknesses and/or increase profitability and responsiveness of the firm. Counter punching can apply to both immediate (i.e., quickly) responses or longer-term efforts.

Attacking rather than Becoming Defensive

Quick Responses (Thompson & Strickland, 1998.): These responses are designed to demonstrate to the consolidated competitor that the small firms are not conceding market share. These responses are often most successful when implemented in a low profile manner (Chen & Hambrick, 1995). Implementation can be largely underway before the tactic becomes visible to the larger competitor:

* Begin avoiding suppliers that also serve the consolidated
firms

* Cultivate your valued suppliers and attempt to be a major
purchaser of their products

* Induce differentiation

* Lengthening warranty coverage

* Reducing delivery time to customers

* Offer free or low cost training to the customers on the use
of the firm's products

* Create and implement simultaneous initiatives in a variety
of areas such as:

** Price cuts

** Increased advertising

** Free samples

** Rotating specials on specific items in the product line

** Aggressive rebate programs

Longer Term Responses (Thompson & Strickland, 1998; Hill & Jones, 1998)--Longer-term approaches are designed to attain or retain influence on the competitive nature of the industry or market segment. These responses help define the competitive forces and often can lead to paradigm shifts that greatly reduce the competitive advantages enjoyed by a consolidated firm:

* Develop and protect proprietary competencies

* Develop product design processes

* Increase production technologies and know-how

* Optimize the mix of value chain competencies--knowing
how much money to be allocated to each element and what
level of resulting competencies to attain

* Develop and sign exclusive agreements with dealers and
distributors (this will help block inroads by the newly
consolidated competitor)

* Develop and maintain a 'war chest' of cash and marketable
securities whose liquidity and interest income can be used
to ride out price wars and other strategies of larger
competitors. Note: Find and work with a bank who has
expertise in cash management strategies for small
businesses.

* Maneuver around the strengths and product-market
penetration of the larger competitor. Find niches (product,
geographic regions, etc.) and areas of differentiation
(special sales and service activities, customized products,
etc.) not easily copied by the larger firm.

* Identify weak-loyalty customers of the consolidated firm
and target them for special advertising and marketing

* Attempt sudden bursts of intense promotional activity to
attract back customers. Note: the timing is crucial when
using this strategy--try random timing, but do not go head
to head with national campaigns financed by the larger
newly consolidated firm.

Final Comment on Strategy Options: All strategies and tactics require resource commitments. Small business owners must (1) find and use competent financial services advisors in order to maintain a healthy capital structure (mixture of debt and equity in the balance sheet), (2) maintain adequate liquidity through effective cash management, and (3) develop realistic seasonal borrowing and lines of credit with a bank that understands the firm's industry. With the advent of both national and international financial institutions and systems, adequate short and long term financing of operations and growth is sufficiently available that difficulties in financing for small business is no longer a strategic disadvantage.

REFERENCES

Cheeseman, H.R. (1998). Business Law, (3rd ed.) New Jersey: Prentice Hall, 853-879.

Chen, M. J. & Hambrick, D. (1995) Speed, stealth, and selective attack: How small firms differ from large firms in competitive behavior, Academy of Management Journal, 38(2), 453-482.

Dunfee, T. W. & F. F. Gibson (1985). Antitrust and Trade Regulation, (2nd ed.) New York: John Wiley & Sons, 235-238.

Gellhorn, E. (1981). Antitrust Law and Economics. St. Paul: West Publishing,

Hill, C. & Jones, G. (1998). Strategic Management Theory, (4th. Ed.). New York: Houghton Mifflin Company, 222-242.

R. C. Bigelow, Inc. v. Unilever, N.V., 867 F.2d 102 (2d Cir. 1989).

Schnitzer, M.C. (1978) Contemporary Government and Business Relations. Chicago: Rand McNally, 67-78.

Singer, E.M. (1981). Antitrust Economics and Legal Analysis. Columbus: Grid, 217-222.

Thompson, A. &.Strickland, A. J. (1998). Strategic Management, (11th ed.). New York: Irwin McGraw-Hill, 163-170; 200-209.

U.S. Department of Justice and Federal Trade Commission (1998). Guidelines for Horizontal Mergers, (3rd ed.) U.S. Government Publications.

United States v. E.I. duPont de Nemours and Company, 351 U.S. 377 (1956).

United States v. Philadelphia National Bank, 374 U.S. 321 (1963).

Joseph Geiger, University of Idaho

Jerry Wegman, University of Idaho