Industries Consolidate to Stay Competitive

Mergers and acquisitions help the big get bigger in an effort to reduce costs, reach more customers and expand product lines.

By IBISWorld Lead Industry Analysts Agata Kaczanowska and Mary Nanfelt

Big companies are getting even bigger, mainly through mergers and acquisitions (M&A), resulting in fast-paced consolidation in various industries. The main driver for M&A is economies of scale, which means that companies earn a higher margin on each additional unit produced. Economies of scale are most prominent when an industry has high input costs, which can diminish when inputs are bought in bulk or if a company integrates vertically with its suppliers. Although consolidation involving vertical integration occurs as well, this report focuses on horizontal integration – the integration between companies that produce similar products within the scope of a single industry.

In addition to economies of scale, other factors that encourage company integration include brand alignment, market reach expansion, globalization and downstream consolidation. Companies seek to acquire brands that fall into their portfolio naturally, either to diversify or narrow on a specific market. Meanwhile, growth through market reach expansion is particularly enticing to brick-and-mortar industries.

Economies of Scale

Food Service Contractors

2007-12 increase in market share: 14.1%

Food Service Contractors specialize in facility management for organizations that demand regular food services, including hospitals, schools, nursing homes and stadiums. The top four companies generate 93.2% of industry revenue. Recently, major company Aramark merged with RMK Acquisition Corporation, and industry leaders Compass and Sodexo have also been very active in acquisitions. Consolidation in this industry is occurring because of significant returns to scale for large operations, which are able to purchase food in bulk and centralize costs like insurance and human resources.

This industry is experiencing increasing globalization, which is also driving M&As. While IBISWorld expects that foreign operators will continue to enter the domestic market, it is more likely that current US-based operators will expand, possibly via acquisition of smaller players in other countries. These expansions are expected to occur across areas of expertise and offer players growth in sales, employment and earnings.

Warehouse Clubs & Supercenters

2007-12 increase in market share: 4.2%

Warehouse Clubs and Supercenters include stores that retail a general line of grocery products and merchandise items, often in bulk, and some require customers to have a membership card. This industry’s low prices and large scope of merchandise is one of the main reasons so many other retail industries like grocery stores are consolidating. Consumers prefer to shop at large supercenters for products rather than specialized retail shops because of low prices and convenience.

Although this industry is the culprit for consolidation in other industries, its top companies are also expanding their market power. In the five years to 2012, the industry’s market share concentration is expected to increase 4.2%; though this rise is primarily due to organic growth. Stores such as Walmart Supercenters and Costco continue opening new retail outlets as consumers increasingly demand the products they retail and the low prices they offer. Large companies increase their buying power among manufacturers by buying in bulk, and then lower prices are then passed on to the consumer. Large retailers are also better able to control distribution: Because of their economies of scale, product distribution tends to be more efficient and bigger companies are able to improve their ability to control stock on hand.

Branding

Distilleries

2007-12 increase in market share: 20.4%

The four largest distilleries increased their market share by 20.4% over the past five years, mainly through acquisitions. These companies now generate 89.7% of industry revenue. Pernod Ricard, which used to be a smaller player and only controlled about 10.2% of the US market in 2006, led the field in acquisition. Pernod’s purchase of Vin & Spirits in 2008 boosted its market share to 12.5% despite some divestitures. Shifts in company market share are mainly the result of branding strategies, which are the driver for distiller acquisitions and divestitures.

Larger firms have a competitive advantage in that they can use sales revenue from well-known products to promote emerging brands. Price and quality are tied together in such a way that many similar-quality products are often priced in a certain range. This nature intensifies competition in the arena, giving major players yet another advantage because they face decreasing costs per each additional unit produced and because they can buy inputs at cheaper bulk prices.

Cigarette & Tobacco Manufacturing

2007-12 increase in market share: 19.3%

The number of companies in the Cigarette and Tobacco Manufacturing industry decreased by an estimated 14 firms over the five years to 2012. This industry is extremely competitive and has a high average profit margin, which incentivizes companies to expand already substantial market shares. However, many consumers have shied away from certain tobacco products because of their negative public perception and the negative health effects of smoking. As a result, larger firms have merged and acquired smaller firms that sell products that are still popular among consumers. For example, Altria, the largest player in this industry, acquired UST Inc. in 2009. UST was a large manufacturer of smokeless tobacco, which is becoming an increasingly popular product with Americans.

Large firms buy smaller companies because having a variety of products is extremely important for survival in this industry. With a variety of tobacco products, industry players can better adjust to changes in consumer preferences. Large firms can also more effectively communicate and negotiate with regulators and distributors. Negotiations are essential to this industry given the volume of lawsuits industry producers face. Therefore, increasing size generally gives companies more money to put toward negotiations and hiring highly qualified staff.

Animal Food Production

2007-12 increase in market share: 12.8%

In the past five years, the industry consolidated as downstream retailers like grocery and pet stores increased their market share. These trends limited the demand for major distribution contracts and, therefore, increased the competition between companies in the industry for such large contracts. In order to better meet demand for large distribution arrangements, companies have merged. Increased concentration also resulted from some major players actively investing in new operations to further strengthen efficiencies from large-scale operations. For example, in 2011, Cargill spent more than $3.0 billion on acquisitions, including Calgary-based Agrium’s commodity-management business that will help Cargill source competitively priced inputs. In the past five years, industry concentration increased 12.8%, with the top four companies now controlling 67.6% of the animal food market.

Consumer sensitivities vary between product segments and are inversely related to the perceived quality of a product or brand. Thus, pricing is the most critical competitive factor for producers of low-grade, generic brands. Nonetheless, the rapidly growing and high-margin pet-food segment has encouraged many producers to switch their production lines from livestock feed to these products. In other words, if a consumer believes a product to be of high quality, price will become less of a factor when considering a purchase.

To attract consumers, high-quality products depend heavily on branding, which large companies can better afford. Industry consolidation is expected to continue in the future through sustained M&A activity, primarily driven by major players such as Cargill, Archer Daniels Midland and Mars. Given that buying in bulk and having nation-wide distribution contracts is imperative to maintaining industry profitability, it is very likely there will be fewer animal food manufacturers servicing wider geographic markets through the next five years.

Expanding Market Reach

Hobby & Toy Stores

2007-12 increase in market share: 14.5%

The Hobby and Toy Stores industry includes companies that sell a broad range of toy and hobby goods, such as traditional dolls and toys, electronic toys, board games, hobby kits and craft supplies. In this highly competitive market, industry concentration has been on the rise. With the pressure of revenue being taken by mass merchandisers and department stores, many companies have found it advantageous to increase their size. For instance, Toys ’R’ Us acquired KB Toys and certain business assets of FAO Schwartz.

High market share is important in this industry because large firms are best able to stock a wide range of products. By having a variety of merchandise, these stores become a one-stop shop for families with toy and craft needs. In addition, larger stores are capable of having exclusive sales contracts. Having exclusive rights to sell certain toys can be a large advantage because it can attract more customers. This industry’s main competitors are department stores and mass merchandisers, so by increasing their size, hobby and toy stores can offer lower prices by buying in bulk and provide a product range that is more diverse than most of their external competitors, such as Target and Walmart.

Arcade, Food & Entertainment Complexes

2007-12 increase in market share: 6.8%

Arcade, food and entertainment complexes includes companies that operate amusement arcades, which are also known as video arcades. In the five years to 2012, market share concentration increased 6.8%. Some companies have left the industry and larger firms engaged in M&As. For instance, in 2011, GameWorks Entertainment LLC acquired several locations from JBC Entertainment, operator of the Jillian’s brand of entertainment centers and billiard halls. This acquisition increased the company’s size by 80.0%.

In this competitive industry it is important for firms to differentiate themselves and is relatively easier for larger firms to do this compared to smaller companies. Larger companies are more likely to have the economies of scale to provide the latest-available and most popular games, which is essential in attracting new and returning customers. They are also able to have competitive pricing since large companies are able to purchase goods in bulk and operate more efficiently. Lastly, arcades depend on their reputation. Having a recognizable franchise, where each establishment is consistent in presentation and games, creates steady expectations and familiarity for consumers.

Future Consolidators

Although the Urgent Care Centers and Vitamin and Supplement Manufacturing industries are not heavily participating in M&As currently, they represent two examples of industries that are more than ripe for M&A activity. Both these industries have strong growth potential and are not far behind the ones discussed earlier. The implementation of The Patient Protection and Affordable Care Act will likely increase the acceptance of dietary supplements as it encourages greater inclusion of alternative practitioners in healthcare. The legislation will also put a new emphasis on primary care, particularly preventative care, providing increases to Medicare and Medicaid reimbursements for primary care over the next five years. A shortage of primary doctors is expected to intensify in the next ten years, which could mean more limited access to healthcare and longer wait times for patients, which will likely result in a greater share of patients using urgent-care facilities.

Along with a strong growth potential, these two industries are ideal for M&As because they have low concentration, moderate to high entry barriers and high profit margins. A straightforward way to gain market share in these profitable industries is to acquire competitors. Through acquiring other companies, vitamin and supplement manufacturers can increase their branding and economies of scale. Through merging, urgent-care centers can also increase their branding along with their market reach. IBISWorld expects these industries to experience a greater degree of consolidation in the next five years.

To download full research reports for the industries discussed in this article, click on the report titles below.

Food Service Contractors, Warehouse Clubs & Supercenters, Distilleries, Cigarette & Tobacco Manufacturing, Animal Food Production, Hobby & Toy Stores, Arcade, Food & Entertainment Complexes, Urgent Care Centers, Vitamin & Supplement Manufacturing