Rogue Missives - Wednesday, December 18, 1996

Rogue Missives

ROGUE ARCHIVES

Wednesday, December 18, 1996

Does Size Matter?
by Jim Surowiecki (Surowiecki)
American capitalism has always had an uneasy relationship with the question of size. While the dominant free-market ideology has preached the virtues of cutthroat competition and the productive effects of firms constantly entering and exiting the stage, American corporations have traditionally done all they could to reduce the risks of competition, to raise the barriers to entry in their fields of business, and to emphasize stability over uncertainty.

In the first part of this century, that effort manifested itself in the support of large corporations for increased state regulation -- of food safety, for example -- that had the effect of forcing smaller firms out of business while simultaneously increasing consumer confidence. While a firm opposition to monopolies dominated political discourse during the Populist and early Progressive eras, during Woodrow Wilson's presidency the answer to big corporations was understood to be not legislation breaking them up, but a federal government powerful enough to check them.

State power increased in response to capitalism's collapse during the Great Depression and to the demands of a centrally planned war economy. But this increase in the role of the government did not translate into a hostility to size. The post-war years, in fact, saw an increasing consolidation of most of America's major industries. By the early 1950s the economist John Kenneth Galbraith would describe the American economy as essentially oligopolistic. And although figures like Senator Estes Kefauver built political careers by conjuring up the supposed threat posed by large corporations, the exact nature of that threat has never been clearly articulated. Certainly the inflated prices that oligopoly was supposed to bring with it have not materialized. And from the perspective of labor, large corporations have proved easier to unionize than small businesses. One large target is preferable, in that sense, to many smaller ones.

The announcement on Sunday that BOEING <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BA)") else Response.Write("(NYSE: BA)") end if %> and MCDONNELL DOUGLAS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MD)") else Response.Write("(NYSE: MD)") end if %> will merge in a $13.3 billion deal may raise the hackles of those for whom size is still a vice, but in fact all indications are that this is a win-win deal for just about everyone involved. The merger, under which McDonnell Douglas shareholders will receive 0.65 shares of Boeing stock for each share of McDonnell Douglas they own, is the latest in a series of mergers and acquisitions in the defense industry, and will create a $48 billion company flush with cash and low on debt that's just entering a boom time in the often painfully cyclical aerospace market.

Regulators from the Federal Trade Commission will scrutinize the merger carefully, but all indications are that, unless commercial airlines protest, approval should be rapid. While the FTC under Bill Clinton has been more careful in its application of antitrust law than it had been between 1981 and 1993, it has not taken the position that consolidation is, in and of itself, a bad thing. And the case of Boeing and McDonnell Douglas really does seem to be one where the strengths of each company complement the other.

Boeing is the world's largest manufacturer of commercial aircraft, and has undergone a rather astonishing renaissance over the past two years. In 1994, Boeing lost the leadership of the world aircraft market to Airbus Industrie, the company formed by a conglomerate of four European nations in order to contest Boeing's dominance. And in the five years between 1990 and 1995, Boeing laid off almost a third of its workers, a process that culminated in a bitter -- and successful -- strike by the Machinists Union.

Since then, though, the company has righted itself in dramatic fashion. Part of that was simply the result of a return to boom times in the industry. But much of it also had to do with the corporation's reinvention of itself as a more aggressive entity. Boeing took back the No. 1 spot in aircraft sales last year, and this year commands something like 55 percent of the market, while some have suggested that it's captured as much as 70 percent of future sales. At the same time, Boeing has expanded the aerospace and defense component of its business, and among other things acquired ROCKWELL INTERNATIONAL's <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ROK)") else Response.Write("(NYSE: ROK)") end if %> defense and aerospace units earlier this year in a $3.2 billion deal that significantly strengthened its position in the defense industry.

More impressively, Boeing is one of two corporations -- LOCKHEED MARTIN <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: LMT)") else Response.Write("(NYSE: LMT)") end if %> being the other -- still in the running to build the new Joint Strike Fighter for the Pentagon, a contract that could ultimately be worth as much as $750 billion. It's also bidding for a contract to build inexpensive rockets to launch satellites, and is developing the Comanche, the next generation of attack helicopter.

McDonnell Douglas has endured a tough year marked by its failure to win the Joint Strike Fighter contract and its announcement that it was going to reduce significantly its efforts in the commercial aircraft arena, so Boeing's interest in the merger may seem surprising. As for McDonnell Douglas, it's hard not to view this as manna from heaven.

McDonnell Douglas is still one of the major players in aerospace and defense, though, and the merger dramatically improves Boeing's future chances of capturing contracts like the Joint Strike Fighter. In this particular case, synergy is probably not an inappropriate word to use, since McDonnell's defense work and Boeing's commercial production will presumably benefit from the union. In addition, the merger adds ten percent of the commercial airline market to Boeing's market share, putting additional pressure on Airbus. Germany, in fact, announced today that it was seeking changes in Airbus' structure and strategy as a result of the merger.

On the most basic level, the merger testifies to the continued dominance of a few corporations in most basic industries. The commercial aircraft industry will be left with essentially two competitors. The American defense industry, which represents essentially a closed market since the Pentagon purchases exclusively from domestic contractors, will most likely go from eight to ten firms to three or four over the next couple of years. The price of NORTHROP GRUMMAN <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: NOC)") else Response.Write("(NYSE: NOC)") end if %>, for instance, rose yesterday because investors assumed that the Boeing announcement would put pressure on Northrup to combine with another firm.

What's interesting about all this is that there's no real evidence that the reduction in the number of competitors necessarily lessens innovation or productivity. (It's worth remembering that the greatest source of technological innovation in the past thirty years, Bell Labs, operated in a monopolistic environment.) Nor is it clear how many competitors are necessary for it to count as competition. Though one might expect the airlines to protest against having just two suppliers to buy from, analysts suggested yesterday that Boeing and Airbus were probably enough to make it count as a free market. Size and market dominance are not, then, necessarily recipes for inefficiency, though they certainly can be.

At the same time, the defense industry presents an interesting and slightly different picture, if only because it's here that the complicated question of national identity and its relationship to corporate power is articulated most clearly. Most major corporations today are, after all, multinational. They move capital abroad at will, and emphasize their corporate identity over the country in which they are chartered. When Intel, for example, opens a new chip plant in Costa Rica, it does so because that's what is most likely to increase the return to Intel's investors, not because it's what is best for America as a nation.

And yet the defense industry exists only because nation-states are the dominant political form of this century, and because those nation-states perceive themselves in competition with or at risk from other nation-states. So while companies like Boeing or Northrop may be multinational, an essential part of their business depends on them remaining, in a sense, explicitly American. At least for now, U.S. helicopters are not built in Mexico.

At the same time, even economists who extol the virtues of free trade argue that the U.S. does have a vested interest in remaining technologically advanced and in having its workers in high-value-added industries like aerospace. From that perspective, the role the government plays in opening foreign markets to U.S. contractors might be seen as a kind of jobs policy, while the oligopolistic nature of the industry comes to look like a boon, not a bane, to American workers.

Unsurprisingly, AFL-CIO president John Sweeney joined the chorus of voices praising the merger. All indications are that no jobs will be lost as a result of the deal, and if anything the position of the Machinists Union should be strengthened, since all Boeing assembly-line workers will now be part of one large bargaining unit.

And investors were similarly pleased. If you had somehow decided to buy McDonnell Douglas last week, you would have seen your shares rise 20 percent in a single day, while the Street was similarly positive about the deal from Boeing's perspective.

The most interesting comment on the whole deal came from industry analyst Wolfgang Demisch, who said that Boeing's only problem would be figuring out where to invest the billions and billions of dollars of profits that would be rolling in over the next few years. It's hard to think of a better problem to have. And it's hard to see how, in this case, size is anything but a good thing.

-- Jim Surowiecki (Surowiecki)

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ROGUE ARCHIVES

Wednesday, December 18, 1996
Does Size Matter? by Jim Surowiecki (Surowiecki) American capitalism has always had an uneasy relationship with the question of size. While the dominant free-market ideology has preached the virtues of cutthroat competition and the productive effects of firms constantly entering and exiting the stage, American corporations have traditionally done all they could to reduce the risks of competition, to raise the barriers to entry in their fields of business, and to emphasize stability over uncertainty. In the first part of this century, that effort manifested itself in the support of large corporations for increased state regulation -- of food safety, for example -- that had the effect of forcing smaller firms out of business while simultaneously increasing consumer confidence. While a firm opposition to monopolies dominated political discourse during the Populist and early Progressive eras, during Woodrow Wilson's presidency the answer to big corporations was understood to be not legislation breaking them up, but a federal government powerful enough to check them. State power increased in response to capitalism's collapse during the Great Depression and to the demands of a centrally planned war economy. But this increase in the role of the government did not translate into a hostility to size. The post-war years, in fact, saw an increasing consolidation of most of America's major industries. By the early 1950s the economist John Kenneth Galbraith would describe the American economy as essentially oligopolistic. And although figures like Senator Estes Kefauver built political careers by conjuring up the supposed threat posed by large corporations, the exact nature of that threat has never been clearly articulated. Certainly the inflated prices that oligopoly was supposed to bring with it have not materialized. And from the perspective of labor, large corporations have proved easier to unionize than small businesses. One large target is preferable, in that sense, to many smaller ones. The announcement on Sunday that BOEING <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BA)") else Response.Write("(NYSE: BA)") end if %> and MCDONNELL DOUGLAS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MD)") else Response.Write("(NYSE: MD)") end if %> will merge in a $13.3 billion deal may raise the hackles of those for whom size is still a vice, but in fact all indications are that this is a win-win deal for just about everyone involved. The merger, under which McDonnell Douglas shareholders will receive 0.65 shares of Boeing stock for each share of McDonnell Douglas they own, is the latest in a series of mergers and acquisitions in the defense industry, and will create a $48 billion company flush with cash and low on debt that's just entering a boom time in the often painfully cyclical aerospace market. Regulators from the Federal Trade Commission will scrutinize the merger carefully, but all indications are that, unless commercial airlines protest, approval should be rapid. While the FTC under Bill Clinton has been more careful in its application of antitrust law than it had been between 1981 and 1993, it has not taken the position that consolidation is, in and of itself, a bad thing. And the case of Boeing and McDonnell Douglas really does seem to be one where the strengths of each company complement the other. Boeing is the world's largest manufacturer of commercial aircraft, and has undergone a rather astonishing renaissance over the past two years. In 1994, Boeing lost the leadership of the world aircraft market to Airbus Industrie, the company formed by a conglomerate of four European nations in order to contest Boeing's dominance. And in the five years between 1990 and 1995, Boeing laid off almost a third of its workers, a process that culminated in a bitter -- and successful -- strike by the Machinists Union. Since then, though, the company has righted itself in dramatic fashion. Part of that was simply the result of a return to boom times in the industry. But much of it also had to do with the corporation's reinvention of itself as a more aggressive entity. Boeing took back the No. 1 spot in aircraft sales last year, and this year commands something like 55 percent of the market, while some have suggested that it's captured as much as 70 percent of future sales. At the same time, Boeing has expanded the aerospace and defense component of its business, and among other things acquired ROCKWELL INTERNATIONAL's <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ROK)") else Response.Write("(NYSE: ROK)") end if %> defense and aerospace units earlier this year in a $3.2 billion deal that significantly strengthened its position in the defense industry. More impressively, Boeing is one of two corporations -- LOCKHEED MARTIN <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: LMT)") else Response.Write("(NYSE: LMT)") end if %> being the other -- still in the running to build the new Joint Strike Fighter for the Pentagon, a contract that could ultimately be worth as much as $750 billion. It's also bidding for a contract to build inexpensive rockets to launch satellites, and is developing the Comanche, the next generation of attack helicopter. McDonnell Douglas has endured a tough year marked by its failure to win the Joint Strike Fighter contract and its announcement that it was going to reduce significantly its efforts in the commercial aircraft arena, so Boeing's interest in the merger may seem surprising. As for McDonnell Douglas, it's hard not to view this as manna from heaven. McDonnell Douglas is still one of the major players in aerospace and defense, though, and the merger dramatically improves Boeing's future chances of capturing contracts like the Joint Strike Fighter. In this particular case, synergy is probably not an inappropriate word to use, since McDonnell's defense work and Boeing's commercial production will presumably benefit from the union. In addition, the merger adds ten percent of the commercial airline market to Boeing's market share, putting additional pressure on Airbus. Germany, in fact, announced today that it was seeking changes in Airbus' structure and strategy as a result of the merger. On the most basic level, the merger testifies to the continued dominance of a few corporations in most basic industries. The commercial aircraft industry will be left with essentially two competitors. The American defense industry, which represents essentially a closed market since the Pentagon purchases exclusively from domestic contractors, will most likely go from eight to ten firms to three or four over the next couple of years. The price of NORTHROP GRUMMAN <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: NOC)") else Response.Write("(NYSE: NOC)") end if %>, for instance, rose yesterday because investors assumed that the Boeing announcement would put pressure on Northrup to combine with another firm. What's interesting about all this is that there's no real evidence that the reduction in the number of competitors necessarily lessens innovation or productivity. (It's worth remembering that the greatest source of technological innovation in the past thirty years, Bell Labs, operated in a monopolistic environment.) Nor is it clear how many competitors are necessary for it to count as competition. Though one might expect the airlines to protest against having just two suppliers to buy from, analysts suggested yesterday that Boeing and Airbus were probably enough to make it count as a free market. Size and market dominance are not, then, necessarily recipes for inefficiency, though they certainly can be. At the same time, the defense industry presents an interesting and slightly different picture, if only because it's here that the complicated question of national identity and its relationship to corporate power is articulated most clearly. Most major corporations today are, after all, multinational. They move capital abroad at will, and emphasize their corporate identity over the country in which they are chartered. When Intel, for example, opens a new chip plant in Costa Rica, it does so because that's what is most likely to increase the return to Intel's investors, not because it's what is best for America as a nation. And yet the defense industry exists only because nation-states are the dominant political form of this century, and because those nation-states perceive themselves in competition with or at risk from other nation-states. So while companies like Boeing or Northrop may be multinational, an essential part of their business depends on them remaining, in a sense, explicitly American. At least for now, U.S. helicopters are not built in Mexico. At the same time, even economists who extol the virtues of free trade argue that the U.S. does have a vested interest in remaining technologically advanced and in having its workers in high-value-added industries like aerospace. From that perspective, the role the government plays in opening foreign markets to U.S. contractors might be seen as a kind of jobs policy, while the oligopolistic nature of the industry comes to look like a boon, not a bane, to American workers. Unsurprisingly, AFL-CIO president John Sweeney joined the chorus of voices praising the merger. All indications are that no jobs will be lost as a result of the deal, and if anything the position of the Machinists Union should be strengthened, since all Boeing assembly-line workers will now be part of one large bargaining unit. And investors were similarly pleased. If you had somehow decided to buy McDonnell Douglas last week, you would have seen your shares rise 20 percent in a single day, while the Street was similarly positive about the deal from Boeing's perspective. The most interesting comment on the whole deal came from industry analyst Wolfgang Demisch, who said that Boeing's only problem would be figuring out where to invest the billions and billions of dollars of profits that would be rolling in over the next few years. It's hard to think of a better problem to have. And it's hard to see how, in this case, size is anything but a good thing. -- Jim Surowiecki (Surowiecki)