576 Making Key Strategic Decisions
“Finally, there is the central justification of the deal: cross-selling each other ’s
products, mainly to retail customers. Over the next two years, Citigroup ought
to be able to generate $600 million more in earnings because of cross-selling.”^9After acquiring Miller Brewing Company in 1970, Philip Morris used its mar-
keting and advertising strength to move Miller from the number 7 to the num-
ber 2 U.S. beer maker by 1977.
Some acquisitions provide strategic benefits that act as insurance against
or options on future changes in the competitive environment. As genetic re-
search has advanced, pharmaceutical firms have used acquisitions to ensure
they participate in the commercial potential offered by this new technology.
The 1998 acquisition of SmithKline Beecham PLC by Glaxo Wellcome PLC
was motivated by Glaxo’s fear of missing out on this revolution in the industry.
SmithKline had entered the genetic research field in 1993 by investing $125
million in Human Genome Sciences, a Rockville, Maryland, biotechnology
company created to commercialize new gene-hunting techniques.
Finally, the acquisition of a competitor may increase market share and
allow the merged firm to charge higher prices. By itself, this motive is not valid
justification for initiating a merger, and any deal done solely to garner monopo-
listic power would be challenged by global regulators on antitrust grounds.
However, market power may be a by-product of a merger done for other rea-
sons. American Airline’s potential bid for USAir, while launched primarily to
thwart a similar attempt by its competition, would also have implications for
market power in the industry.
American is particularly worried about the prospect of USAir falling into
United’s hands. Nabbing the carrier for itself would give American coveted
slots at Chicago’s O’Hare, New York’s LaGuardia, and Washington’s National
Airport.^10Cost Reductions Improved efficiency from cost savings is one of the most
often cited reasons for mergers. This is especially true in the banking industry,
as the recent merger between J.P. Morgan and Chase Manhattan makes clear.
The key to executing the merger, say analysts, will be how quickly Chase can
trim its expenses. It plans to save $500 million through job cuts, $500 million by
consolidating the processing systems of the two institutions and $500 million
by selling off excess real estate. In London, for example, the two banks have 21
buildings, and they won’t need all of them.^11In total, there is an estimated $1.5 billion of annual savings. The link between
this and value creation is easy for investors to understand and the benefits from
cost reductions are relatively easy to quantify. These benefits can come from
economies of scale, ver tical integration, complementary resources,and the
elimination of inef ficient management.
Economies of scale result when a certain percentage increase in output
results in a smaller increase in total costs, resulting in reduced average cost. It