What Is Industry Consolidation And Why Does It Happen?

Lately, it seems like big corporations are merging left and right. You likely see headlines every week about two major companies combining forces through acquisitions or mergers.

This trend of companies within an industry joining together is known as industry consolidation. As larger players grow even bigger by absorbing smaller competitors, the total number of companies within that industry shrinks.

So why is consolidation happening so rapidly these days? And what does it mean for businesses and consumers? As a smaller compaany operating within a consolidating industry, how do you adapt and compete against industry giants?

These are the types of questions we’ll explore in this article. Our aim is to provide a balanced view of industry consolidation – the forces driving it, the potential pros and cons, and how businesses can navigate a consolidating industry landscape.

To get started, let’s define industry consolidation in plain terms. Basically, it refers to a shrinking number of companies within an industry as larger players merge with or acquire smaller competitors. We’ll then look at some common reasons why consolidation is occurring at such an accelerated pace. Finally, we’ll examine the wide-ranging impacts on businesses and consumers in both positive and negative ways.

With a better understanding of industry consolidation, businesses large and small can make strategic choices to survive and succeed within a consolidating industry. So that’s what we’ll aim to provide in this article – practical insights for navigating the trend of industry consolidation.

What is Industry Consolidation?

At its core, industry consolidation refers to the merging together of previously separate businesses or companies within an industry. This typically occurs through mergers and acquisitions that result in a smaller number of larger competitors dominating that industry.

When companies consolidate, the overall structure of their industry transforms. There are fewer players controlling an increasing share of the market. In some cases, a single company may eventually come to dominate an entire sector.

The end result is known as industry or market concentration – where a small number of large companies account for the majority of revenue, production, and supply within that industry. As companies combine operations through mergers and acquisitions, industry concentration naturally rises.

So in simple terms, industry consolidation entails two main aspects:

1. A decrease in the total number of competitors within an industry as smaller players are acquired by or merged with larger companies.
2. A simultaneous increase in industry concentration as the market becomes dominated by fewer but much larger and more powerful corporations.

Together, these two effects fundamentally change the competitive dynamics of that industry. Industry consolidation results in higher levels of market concentration as the industry shifts from one with many smaller rivals to one with a few dominant incumbents.

Why Does Industry Consolidation Happen?

Economies of scale

One of the primary forces driving industry consolidation is the pursuit of economies of scale. When companies merge and consolidate, the combined entity can gain significant scale advantages over smaller competitors.

Larger companies enjoy a range of economies of scale that help lower their costs and improve efficiency. Some of the key scale benefits that result from industry consolidation include:

• Savings from consolidating operations and facilities. By combining production, distribution, and office networks, the larger company eliminates redundant expenses.

• Cost reductions in procurement and supplies. The increased purchasing power of a larger company allows it to negotiate better deals with suppliers.

• Synergies in research and development. By pooling R&D resources, the consolidated company can advance new technologies faster and at a lower total cost.

• Optimization of supply chains and logistics. The scale of the larger entity helps streamline supply chains and warehouse operations for lower overall costs.

All of these factors contribute to the economies of scale that companies seek through industry consolidation. They hope the cost savings and efficiency gains will outweigh the difficulties of integrating two separate businesses.

For example, when United and Continental Airlines merged in 2012, they cited $1-$1.2 billion in potential annual synergies from consolidating routes, fleets, maintenance facilities, and other operations.

Increased market power and pricing power

In addition to economies of scale, companies also consolidate to gain greater leverage and pricing power within their industry.

When previously smaller players merge into a single, larger entity, they often acquire the ability to influence market dynamics and set prices in ways that benefit their profits.

For instance, the merged company may have more freedom to raise prices with less risk of losing market share. Typically, larger companies face less competitive pressure, giving them greater pricing power.

By acquiring or merging with rivals, the consolidated company also reduces direct competition. This allows it to operate with less competitive restraint and exert more influence over supply, demand, and distribution channels.

All of these effects contribute to the “increased market power” that companies pursue through industry consolidation. By growing significantly larger relative to competitors, they gain the ability to shape market forces to their advantage in terms of profits and operations.

However, regulators aim to curb excessive consolidation and market power that becomes anti-competitive. Antitrust authorities seek to preserve competition within an industry for the benefit of consumers, businesses, and the broader economy.

Seeking new growth opportunities

Another key factor driving industry consolidation is the need for growth and the opportunities that consolidation creates. Larger companies seek growth through mergers and acquisitions to remain competitive.

When companies consolidate, the combined entity gains access to several potential sources of growth that were difficult for the smaller separate entities:

• Access to new markets and customers – The merged company can now enter markets and sell to customers that were previously out of reach due to its larger size and economies of scale.

• Broader product offerings – The consolidation brings together the separate product lines of the merging companies, creating a more robust and diverse set of offerings for both existing and new customers.

• Advanced technologies – The combined company may gain access to the advanced technologies, expertise, and intellectual property of the acquired business to spur innovation.

• Talent and expertise – The consolidation provides an infusion of new talent, management expertise, and operational know-how that can improve efficiency and unlock opportunities for growth.

For example, when AOL acquired Time Warner in 2000, AOL’s leadership cited growth through access to Time Warner’s media and entertainment assets as a primary motivation for the merger.

Financial incentives

Financial incentives and profit potential are another key drivers of industry consolidation. Companies pursue mergers and acquisitions to realize specific financial gains that benefit shareholders and stakeholders.

Some of the primary financial incentives for companies consolidating within an industry include:

• Cost savings and synergies – As discussed earlier, consolidation allows companies to achieve economies of scale that reduce operating expenses. The cost savings are seen as a potential source of higher profits.

• Increased revenues and market share – The combined entity after consolidation has greater revenue potential due to its larger size, wider market reach, and broader product offerings.

• Higher stock prices and valuations – Successful industry consolidation that results in revenue growth, cost savings, and synergies can boost the stock price and valuation of the consolidated company.

• Attractive tax benefits – Some countries offer tax benefits for mergers and acquisitions that incentivize industry consolidation.

• Access to capital – Larger, consolidated companies typically have easier access to lower-cost capital through loans and bonds.

For shareholders and stakeholders, industry consolidation is seen as a way to optimize returns through greater efficiencies of scale, increased pricing power, and other financial benefits. However, the financial gains must outweigh the risks and costs of integration for consolidation to make business sense.

Globalization

Globalization is another major force driving consolidation within many industries. As national borders become less significant for trade and commerce, it has become easier for companies in different countries to merge and form larger multinational entities.

Some ways in which globalization has facilitated industry consolidation on an international scale include:

• Lower trade barriers – The reduction of tariffs and trade restrictions has made it easier for companies in different countries to consolidate operations.

• Harmonization of regulations – With many countries adopting similar laws and regulations, the process of merging companies across borders has become more streamlined.

• Advancements in technology – Technologies like the internet, cloud computing, and mobile devices have enabled easier communication, coordination, and integration of geographically dispersed operations.

• Growth opportunities in emerging markets – As new economies open up and grow rapidly, companies seek to consolidate in order to tap into those international opportunities for expansion.

• Pooling of talent and resources – The ability to combine human capital and assets on a global scale has become a significant incentive for multinational consolidation.

For example, the beverage industry has seen extensive consolidation through mergers of companies based in different countries, such as Anheuser-Busch InBev (Belgium/U.S.), Coca-Cola FEMSA (Mexico), and Heineken (Netherlands).

Effects Of Industry Consolidation

Positive Effects

While industry consolidation can have drawbacks, there are potential benefits as well – especially for consumers in the form of lower costs and prices.

For one, consolidated companies sometimes pass on some of their realized cost savings to consumers through lower prices. This has happened in industries like airlines, telecom, and banking after major mergers.

The higher efficiency and productivity of consolidated companies also enable them to provide better quality products and services. Customers may benefit from the combined expertise, assets, and resources of the merged entities.

By joining together R&D teams and resources through consolidation, companies also have the potential to advance new technologies and innovations at a faster pace. This kind of spur in innovation can work in consumers’ favor over time.

The combined product offerings of merging companies may additionally provide consumers with a wider selection of goods and services from a single provider.

And while individual companies may downsize post-merger, industry consolidation can sometimes contribute to overall job growth within a sector. This happens when consolidated companies expand rapidly into new markets and regions.

Negative Effects

While industry consolidation has some potential benefits, it also brings a number of risks and drawbacks – particularly for smaller businesses and consumers.

Some of the negative effects of industry consolidation include:

• Higher prices due to less competition – With fewer competitors in the market, consolidated companies face less pressure to keep prices low. This can lead to higher prices for consumers and business customers.

• Job losses from the consolidation of operations – Though industry consolidation can potentially create some jobs through company growth, it often results in job cuts from consolidating plants, offices, and other functions.

• Customer issues during business integration – The process of integrating two separate companies often causes disruptions, issues, and problems for customers in the transition period.

• Vulnerability if a dominant company fails – If a heavily consolidated industry becomes reliant on one or few dominant companies that later face issues, the whole sector can be negatively impacted.

• Barriers to entry for small businesses and startups – Industry consolidation makes it harder for small players to enter the market and compete against giant incumbents. This stifles competition, innovation, and entrepreneurship over time.

• Regulatory pressure to prevent anti-competitive behavior – Consolidated companies face greater scrutiny from regulators to ensure they do not engage in monopolistic or anti-competitive practices that harm the market.

Regulatory Issues

Industry consolidation often raises regulatory issues, particularly around potential monopolies and anti-competitive effects. Regulators work to limit excessive consolidation that could harm market competition.

Some of the regulatory concerns around industry consolidation include:

• Potential monopolies – When consolidation within an industry gets to the point where one or few companies control the vast majority of the market, it can create an illegal monopoly that stifles competition. Regulators step in to prevent this.

• Anti-competitive practices – Consolidated companies may engage in anti-competitive behaviors like predatory pricing, exclusive contracts, and tying arrangements that regulators aim to curb.

• Impact on small businesses and startups – Excessive industry consolidation can make it nearly impossible for new, small businesses to enter the market and compete effectively. Regulators seek to maintain a fair environment for entrepreneurship.

• Harm to consumers – When consolidation limits competition and allows companies to raise prices without improving value, it often harms consumers and the broader economy. Regulators intervene to protect the interests of the public.

• Merger reviews and approvals – Government agencies closely review large mergers and acquisitions to determine their potential impact before approving or blocking deals in the public interest.

Importance of adapting to industry consolidation for businesses

Regardless of size, businesses operating within consolidating industries must find ways to adapt and thrive. Industry consolidation changes competitive dynamics that all players must navigate.

For larger companies pursuing consolidation through mergers and acquisitions, the key is to realize potential synergies and scale benefits while minimizing integration risks. They must deliver on promised cost savings, revenue growth, and efficiency gains.

For smaller companies facing industry consolidation, steps to adapt may include:

• Differentiate through innovation, customer experience, and niche market expertise

• Form strategic partnerships and alliances with larger brands

• Specialize in specific, high-value services and products

• Leverage technologies like AI, automation, and cloud computing to achieve some scale benefits

• Consider consolidation with complementary businesses for greater scale and stability

• Monitor larger competitors closely for opportunities

Conclusion

In this article, we have discussed what industry consolidation means, explored some of the common reasons driving it, and examined both the potential pros and cons for businesses and consumers.

To recap, industry consolidation refers to the merging together of previously separate companies within an industry, which leads to fewer but larger competitors dominating that sector. Companies consolidate to achieve economies of scale, gain market power, pursue growth opportunities, realize financial incentives, and access global possibilities.

However, industry consolidation also brings risks like higher prices, less competition, job losses, customer issues, and barriers for smaller players. Regulators work to prevent anti-competitive effects from excessive consolidation.

Regardless of size, businesses must adapt strategically to the changing competitive landscape shaped by consolidation. Success will depend on how effectively they identify and respond to new challenges, while also seeking ways to benefit from potential upsides.

With a thorough understanding of industry consolidation – what drives it, what effects it can have, and how businesses must adapt to it – companies large and small can make choices that allow them to survive and thrive within consolidating industries.