Profitable Growth by Acquisition 577doesn’t matter whether this increased output is generated internally or ac-
quired externally. When the firm grows to its “optimal” size, average costs are
minimized and no further benefits are possible. There are many potential
sources of economies of scale in acquisitions, the most common being the abil-
ity to spread fixed overhead, such as corporate headquarters expenses, execu-
tive salaries, and the operating costs of central computing systems, over
additional output.
Vertical integration acquisitions can reduce costs by removing supplier
volatility, by reducing inventory costs, or by gaining control of a distribution
network. Such benefits can come in any industry and for firms of all sizes.
Waste Systems International, a regional trash hauler in the United States, ac-
quired 41 collection and disposal operations between October 1996 and July
1999 with the goal of enhancing profitability.
The business model is fairly straightfor ward. Waste Systems aims to own the
garbage trucks that pick up the trash at curbside, the transfer stations that con-
solidate the trash, and the landfills where it’s ultimately buried. Such vertical
integration is seen as crucial for success in the waste business. Owning landfill
space gives a trash company control over its single biggest cost, disposal fees,
and, equally important, produces substantial economies of scale.^12One firm may acquire another to better utilize its existing resources. A chain
of ski retailers might combine with golf or tennis equipment stores to better
utilize warehouse and store space. These types of transactions are typical in
industries with seasonal or very volatile revenue and earnings patterns.
Personnel reductions are often used to reduce costs after an acquisition.
The savings can come from two sources, one being the elimination of redundan-
cies and the second the replacement of inefficient managers. When firms com-
bine, there may be overlapping functions, such as payroll, accounts payable, and
information systems. By moving some or all of the acquired firm’s functions to
the bidder, significant cost savings may be possible. In the second case, the tar-
get firm managers may actually be making decisions that limit or destroy firm
value. By acquiring the firm and replacing them with managers who will take
value-maximizing actions, or at least cease the ones that destroy value, the bid-
der can effect positive changes.
The U.S. oil industry in the late 1970s provides an excellent example of
this. Excess production, structural changes in the industry, and macroeco-
nomic factors resulted in declining oil prices and high interest rates. Explo-
ration and development costs were higher than selling prices and companies
were losing money on each barrel of oil they discovered, extracted, and re-
fined. The industry needed to downsize, but most oil company executives were
unwilling to take such action and as a result, continued to destroy shareholder
value. T. Boone Pickens of Mesa Petroleum was one of the few industry partic-
ipants who not only understood these trends, but was also willing to act. By ac-
quiring several other oil companies and reducing their exploration spending,
Pickens created significant wealth for his and the target’s shareholders.^13