De-Scaling of America
De-Scaling of America
The stock market run-up at first was a reaction to undervaluation
dating back to the late 1960s. That correction has long since
been made, and the market, despite recent wild gyrations, now
appears out-of-whack in the face of the bewildering array of
problems that surface daily at bellwether companies.
Speculation explains much of inflated stock price levels, but
an equally important reason is tied to the corporate raiders. In
brief, so called "break-up value" of stocks is setting the pace --
that is, the securities analysts' assessment of the market value
of big firms if they were to be taken over, split into pieces and
sold off. (In fact, some suggest that the crash of October 19 was
triggered by the sharp drop of stocks, targeted by raiders,
following the announcement of a proposed stiff tax on takeover
activities.) Underpinning the raiders' activity is the junk bond
market -- another product of the reassessment of scale. The
creation of that market stemmed from the discovery that giant
firms' bonds were relatively overrated and smaller firms' bonds
were relatively underrated.
Further evidence of this overvaluation of huge institutions comes
from economist Frederic Scherer, who studied 15 subsidiaries of
conglomerates that had been sold off to their managers. All but
one showed substantial improvement in profit despite the heavy
debt burden that accompanied the buyouts. Among the reasons for
the dramatic improvement were: "Cost cutting opportunities that
had previously gone unexploited. Austere offices were substituted
for lavish ones. Staffs were cut back sharply. Make-versus-buy
decisions were re-evaluated and lower-cost alternatives were
embraced ... "
A recent Business Week analysis of Mike Dingman and his Henley
Group underscores the point. Dingman and Ed Hennessy split up
Allied-Signal Inc. in 1986, with the former creating the Henley
Group out of $7 billion in questionable assets; almost all 35
operations were in the red. In just 18 months, he has turned all
but one around, and sold off many for a high profit. His formula
is a familiar one: "Cut costs and management layers, make
decisions at the bottom, get closer to customers, and help
managers buy stock so they share rewards and risks." The outcome
includes Fisher, moving from a $99 million loss to a $99 million
profit; Wheelabrator, from plus $10 million to plus $93 million;
and General Chemical, from minus $4 million to plus $87 million.
And only a few weeks before, the same magazine reported on Sybron
Corporation's progress following a leveraged buyout. When
management took the firm private, there were 17 business units, a
corporate staff of 145, debt of $315 million and operating profit
of $27 million on $529 million in sales. Just 17 months later,
only six units were left (the others were sold), the staff had
been reduced to 24, the debt was down to $65 million and earnings
were up to $52 million on $242 million in sales.
Down-scaling has become so common that I don't even raise an
eyebrow when I see an article such as the one in a recent
Financial World saying that Loews Corporation, owner of CBS, may
come under intensive raider scrutiny because its share price is
$77 (October 1987), and a security analyst from Drexel Burnham
Lambert says "a conservative estimate of Loews' breakup value is
about $120 a share."
A recent Forbes magazine cover story, titled "The Protean
Corporation" and describing the new look of winners, parades this
strange new language, too: big factories close, numerous small
ones open in their stead; big firms "clumsy and rigid";
"conglomerates are de-conglomerating" with the stock market as
rewarding the de-conglomeration; "vertically integrated
corporations are dis-integrating;" "the rigid bureaucratic
corporate structure ... is breaking apart." In fact, in any few
weeks of perusing business journals, you will come across phrases
like: "micro-brewers" (beer), "micro-mills" (steel), "mini-
factory," "industrial boutique," "gourmet semiconductor,"
"boutique farming," "de-integrate," "de-merge," "hollow
corporation,," "store within a store," "factory within a
factory," "sell-off," "spin-off," "fragmented markets becoming
pulverized." University of California at Berkeley Business School
Dean Ray Miles sums it up nicely, "Current 'merger mania,
notwithstanding, it seems likely that the 1980s and 1990s will be
known as decades of large scale disaggregation."
The industry-by-industry evidence is the clincher. I began my
research for In Search of Excellence in 1976 with a
visit to Sweden. Their serious question was whether Volvo was big
enough to compete on the world auto market. Now, one seriously
questions GM's ability -- because it's too big. Meanwhile, Volvo,
BMW and Honda, each a small fraction of GM's size, are thriving.
In computers, IBM is taking a beating from the top of its market
(Cray Research) to the middle (Digital Equipment) to the bottom
(Apple, Compaq). Its biggest competitor, Digital, is barely a
fifth of IBM's size.
The story of giantism's increasingly visible burdens is repeated
in packaged goods, semiconductors and health care alike. In the
latter industry, remember that Hospital Corporation of America
was the darling of the stock analysts just a couple of years ago.
Urged on by a board of directors loaded with chief executives of
America's largest firms, it went about the country buying up
hospitals to take advantage of apparent scale economies. The firm
suffered huge losses, and recently was forced in a fire sale to
unload 104 of its 236 hospitals.
Our attachment to large scale runs deep, and the headlines still
feature the big mergers among the big firms. But the real news of
America's economic transformation features prefixes, such as "de-
," "dis-" and "mini-."
(c) 1987 TPG Communications.
All rights reserved