Beat the consolidators

A frenzy of mergers and acquisitions is creating big competitors in what had been fragmented industries. SMEs need new strategies to take on these new goliaths. By MIKE PRESTON.

By Mike Preston

The economy is booming, but SMEs are facing increased competitive pressure like never before. Private equity predators and exiting baby boomers have triggered a merger and acquisition frenzy, creating large market-dominating conglomerates in many previously fragmented industries.

The newly created giants are able to use massive resources and economies of scale to put the squeeze on smaller competitors. For SMEs in rapidly consolidating industries, this means facing three options: sell, die, or develop strategies to beat the market goliaths at their own game.

The value of global mergers and acquisitions activity in the first quarter of 2007 totalled $US1.2 trillion, according to global research firm Dealogic. This represents the biggest single figure for a quarter the firm has ever recorded and is 23% higher than the first quarter of 2006.

It is a similar story in Australia. The Ernst & Young M&A Index for 2006 shows the value of mergers and acquisitions in Australia last year increased 55% to a record $36.3 billion. Ernst & Young partner John Allerton says there is every sign merger and acquisition activity would reach even greater heights in 2007.

Phil Ruthven, the chairman of business information company IBISWorld, says there is no doubt the high level of merger and acquisition activity will lead to greater consolidation over the next five years.

The flow of money to private equity managers who use “roll-up” or “buy and build” strategies to buy up and consolidate small players in fragmented industries is a noticeable part of this trend, Ruthven says. The sheer number of baby boomers reaching retirement age also means there is an increased flow of businesses ripe for consolidation hitting the market.

But, Ruthven says, it is the basic drive towards greater profits coupled with the availability of relatively cheap funds to fuel growth that is most responsible for the growth of big players in previously fragmented markets.

“Companies are searching for economies of scale… or it can just be that a business has a better strategy and now they’ve got the money to implement it. Take hardware retail, for example; Bunnings didn’t need to grow by acquisition, they just went in and grabbed half the market by being smarter than their competitors,” Ruthven says.

Who is feeling the consolidation squeeze?

Although merger and acquisition activity is up across the economy, Professor Michael Schaper, a director of the International Council for Small Business, identifies insurance, retail, heavy manufacturing and childcare as sectors that have experienced substantial consolidation in recent years. He says real estate, clothing and apparel, air-conditioning/refrigeration and the hotel industry are about to enter a consolidation phase.

Within sectors experiencing market consolidation, Schaper says, increased competitive pressure from big competitors tends to fall more heavily on larger SMEs.

“Smaller players find it easier to survive because they tend to be more entrepreneurial and nimble and usually occupy a niche within a larger industry,” Schaper says. “Medium-sized firms often come head to head with bigger players, they are more of a threat and so they can be the focus of intense competitive pressure.”

SMEs that are part of an industry supply chain are also likely to come under increased pressure in consolidating markets, as big businesses are more likely to operate on a scale where it is economical to bring supply in-house, Schaper says.

Beat the big boys at there own game

The arrival of a big competitor does not have to spell the end for an SME, but it can mean some hard decisions have to be made. Nick Storer, chairman of accountancy firm Bentleys MRI and an adviser to SMEs, says business owners have to choose between a growth or a niche strategy.

He says SMEs will sometimes be able to survive by focusing their operations on a niche market a large competitor cannot or will not operate in. For businesses without that option, the only way forward may be to take the market against a competitor that enjoys economies of scale and superior financial resources.

“An SME that decides to fight it out with a big business competitor really has no choice but to go for growth. Once that decision is made, it is a matter of going back to financiers and look at how to fund the growth they need to compete,” Storer says. “That’s often not easy for an SME that has been funded with retained profits put in by family owners for 100 years.”

But while sheer size clearly gives big business some important advantages, it can also mean they are further removed from their client base than an SME that is dedicated to a particular industry sector or geographic location.

Dr Colin Benjamin, the chairman of business consulting firm Marshall Place Associates, says SMEs need to use these advantages to strengthen their market position and build barriers to entry by competitors. He offers three strategies to achieve this.

1. Know your market. Larger businesses tend to employ a more generic marketing strategy that works across their operations. This provides an opening for SMEs. “They need to focus their sales force and take advantage of the fact they are closer to customers to deepen market penetration,” Benjamin says.

SMEs can reinforce this advantage by devoting resources to comprehensive market research. ”It is vital SMEs talk to the customers they need to reach. A well researched customer relations approach will give an advantage over someone whose is just using advertising,” he says.

2. Add value. Where an SME’s primary offering is a product, adding a support service can help to further entrench the business within a market and add a new revenue stream.

Economies of scale and supply chain advantages give larger businesses a cost advantage when it comes to production. “You must compete on service, relying on a basic product in the face of a large competitor will result in decline,” Benjamin says.

3. Build alliances. By joining forces with other SMEs who are direct competitors, it can be possible to achieve some of the benefits large businesses achieve from economies of scale. Benjamin says an alliance between businesses in related sectors in the same geographical territory, or associated parts of the value chain, will often work to mutual advantage.

“Strategic alliances for shared marketing or to integrate parts of the supply chain can be used cut costs substantially,” Benjamin says.

Some industries have already gone through the consolidation wringer, for others it is just beginning, but it is a phenomenon all businesses must be prepared to face. But by adopting strategies to exploit their natural advantages, smaller businesses can survive – and thrive.