Restructuring and its implications for business economics

Business Economics, Jan, 1998 by J. Fred Weston, Piotr S. Jawien, E. James Levitas

Restructuring has been a major force in the world economy at least since the 1970s. Restructuring includes takeovers, mergers, divestitures, spin-offs, split-ups, financial recapitalizations, and going private transactions. This paper discusses: (1) some overall magnitudes, (2) case studies to illustrate the types of forces operating, (3) some generalizations to place the case studies into a framework, and (4) implications for business economics.

The total purchase price of merger and acquisition transactions during the period 1980-96 has been approximately $3 trillion [Mergerstat Review, 1997]. Another measure is how individual firms have been impacted. A study was made of the 1,064 firms listed in the Value Line Investment Survey at year-end 1981. By numbers, 57 percent of the firms had engaged in tender offers, mergers, and/or defensive restructuring between 1982-89 [Mitchell and Mulherin, 1996]. Thus, more than half the firms followed by a major investment service engaged in restructuring during an eight-year period. We next examine impacts on individual firms.

SOME CASE STUDIES OF RESTRUCTURING

Many types of restructuring take place: (1) turnarounds (Scott Paper), (2) major strategic refocus (Intel), (3) strategic readjustment (AT&T), (4) demand shifts (aerospace/defense), and (5) technological innovation (tires).

Turnaround (Scott Paper)

The Scott Paper case is an example of a classic turnaround. It has been well documented by its chief architect [Dunlap, 1996]. When Al Dunlap was hired to run Scott Paper in early 1994, the company was in crisis. Scott had lost $277 million in 1993; Scott was on credit watch with over $2.5 billion in debt, its stock price had been declining. Dunlap presents four rules for a successful restructuring:

1. Form the right management team. Poorly performing executives were fired, including 70 percent of upper management in the first year. New executives with strong track records were brought in. Dunlap hired fourteen experienced marketing directors from Kimberly-Clark, Procter & Gamble, Colgate-Palmolive, and Coca-Cola. He developed a small inner circle of trusted executives with diverse skills and personalities.

2. Cut costs. Payroll was reduced 35 percent by cutting 11,200 jobs. Procurement was consolidated on a worldwide basis. The items stocked in inventories were reduced from 11,000 to 2,000. Executive perks (jets, cars, beach houses) were eliminated. The opulent corporate headquarters were sold, alternative space was rented. Scott outsourced many functions. Dunlap followed the principle of doing in-house only what was perceived to give the company a competitive advantage.

3. Focus on core business. Unrelated businesses, such as health care, food service, and a cogeneration power plant, were sold. Scott sold $2 billion in noncore assets within the first year. Dunlap focused on high growth products within the core business, selling off the coated paper activity for $1.6 billion.

4. Develop a strategy. The product line was pared-down. Dunlap eliminated 31 percent of the consumer product items offered. Testing the "Rule of 55" showed that 50 percent of the products produced only 5 percent of its revenues and earnings. So the number of products was reduced by more than 500 and domestic warehouses from seventy to ten. The remaining products achieved a sales growth of 24.5 percent and operating margins of 20.4 percent. Marketing efforts were refocused around a unified product line, with the slogan, "Scott the world over." This saved millions in advertising and promotional expense. Executive pay was tied to shareholder value. Dunlap himself invested his personal wealth plus substantial borrowings. Scott's top ten executives owned $10 million of company stock. Stock option awards were made to 10 percent of Scott employees. Stock awards were not granted unless performance targets were met.

The sale of Scott to Kimberly-Clark was announced on July 17, 1995. Scott's market value had increased $6.5 billion during Dunlap's tenure. At the time of the Scott acquisition, Kimberly-Clark's stock price was about $60. On August 29, 1997, it had risen to $110. The Spring 1997 edition of Moody's Handbook of Common Stocks noted that Kimberly-Clark "continues to benefit from its merger with Scott Paper, which has fueled improved earnings..."

Creative Destruction (Intel)

The second case study involves a major shift in the nature of an industry. This phenomenon has been called creative destruction [Schumpeter, 1942], major shocks [Gort, 1969], or major discontinuities [Drucker, 1989]. When this happened to Intel, its chairman, Andrew Grove [1996], called it the "Ten Times" factor or "strategic inflection points." Grove describes how the Japanese produced higher-quality memory chips priced "astonishingly low" (p. 87). By the mid-1980s, Intel's market share had plummeted. What to do? "After all, memories were us... our identity" (p.88).

Intel made the very difficult decision to exit the memory chip business to concentrate on micro-processors. This also involved changing the composition of its executive group to become at least 50 percent software experts. The resulting success at Intel has been spectacular, with 80 percent of the world's computer production using Intel microprocessors. Intel's stock price (adjusted for splits) rose from $1.40 in 1986 to $93.12 on September 26, 1997 (down from a high of $102), a compound rate of increase of 46 percent per annum.