Case Background
This case study focuses on the H.J. Heinz Company (from now on, Heinz), one of the three baby food market leaders. In order to increase profits and capture a larger niche industry market, on February 28, 2000, proposed a merger for $185 million (100% voting power) with another market leader, Milnot Holding Corporation (hereinafter Beech-Nut).
Before the merger, Heinz had 15.4% of the market, while Beech-Nut had 17.4% — overall; the companies differed little in terms of performance. The third player in this market was Gerber Products Company (hereinafter Gerber), which held 65% of the market share and featured brand recognition attributes, a wholesale sales strategy, prevalence in local supermarkets, and high audience loyalty. Thus, Heinz’s decision was based on a desire to capture more market volume and become a stronger competitor for Gerber, which included increasing the customer base and multiplying profits.
In general, a corporate merger is not a problem and brings tangible benefits to the parent company. One such benefit is the synergies that result from the complementary functions of the merging companies and exit in the form of company growth, increased market share and scale effects, and a number of additional long-term benefits, including a stronger negotiating position (Sohani & Dake, 2021).
Nevertheless, the main threat to an effective merger is the anticompetitive effect, the essence of which is to reduce the competitive forces in the marketplace, monopolizing the business (Johnson, 2001; Fathollahi et al., 2022). The consequences of such a merger may be an increase in the market power of the company and, consequently, prices for the end consumer, as well as a decrease in quality and a reduction in innovation as a result of the lack of helpful pressure from competitors.
Moreover, the merger could lead to adverse effects in the form of the formation of a dominant player in the market using price-fixing practices, unfavorable agreements for the consumer, and exclusive deals, which could have a detrimental and destructive effect on smaller competitors in the market who are not the leaders. It was this problem that was a key factor for Heinz that led the Federal Trade Commission to oppose this merger for fear of reducing competition in a sparsely saturated market for baby food products (Johnson, 2001).
Thus, the main problem with this case is that a merger of two companies is not an acceptable and correct tactic for the industry market in the long run, but this is the desire that Heinz expresses, seeing positive effects for itself in the merger.
Identifying the Root Reasons
The root reason Heinz planned the merger in 2000 is a vision of the critical benefits that such a move would bring to the company and to end consumers. The main argument of both players for the second place in the industry market is the lack of intense competition between them: they are not substitutes and are rarely present in the same supermarket, so the merger will not lead to severe competitive losses (Leary, 2001). This is supported by the numbers because, in those regions where Heinz sales are high, Beech-Nut sales are meager: 72% versus 4%. The opposite is true; in regions that account for 80% of Beech-Nut sales, Heinz sales are only 2%, according to the topical scenario.
Moreover, the company sees tangible synergies in the merger, indicating that the benefits will outweigh the competitive losses. This should allow the parent company to optimize production, make efficient use of available resources, and manage pricing in an organized manner, which cannot be accomplished in the current environment of fragmented businesses.
In its current state, Heinz is in a phase of economic stagnation (as of 1998-2001), showing no significant increase in profits and having risks to creditors in the context of debt repayment (Current Ratio < 2) (H.J. Heinz Company, 2001). In addition, another argument that both companies see before them is the possibility of combining resources, production capacity, and innovation in order to compete more effectively with the critical market leader, Gerber.
To put it another way, the fundamental predictor of the decision to merge is the understanding of the benefits of advantage over risk and the desire to win a larger share of the industry market, including an improved experience for the consumer.
Applying the Economic Model
In order to better understand the situation, it is necessary to consider the various market factors that can affect the problem. In the context of the outlined problem and to understand the root cause that made Heinz think about the merger process, it is necessary to refer to the Industrial Organization Model (IOM).
IOM is a theoretical concept that is used to analyze company behavior in market structures under monopoly, duopoly, oligopoly, and perfect competition (Wang et al., 2019). In general, this model is used to form an understanding of the company’s context in the external environment, that is, to answer the question of how the market, competitors, and governments might affect the company’s decisions and affect Heinz’s economic performance. It is the IOM paradigm that is used to assess the problem that Heinz faced, that is, the failure to resolve the merger.
High Concentration Market
A highly concentrated market responds to a context in which a small number of companies have a considerable market share. For the baby food industry in the US, three companies have a combined 97.8%, which corresponds to a critically high concentration. This is confirmed by the Herfindahl-Hirschman Index, which was 4,775 for the current market and would rise to 5,285 in a consolidation environment, according to the scenario. In other words, the concentration of such a market would increase even more, which would obviously be an obstacle to effective competition.
A Barrier of Entry
In such a market, there is an extremely high barrier to entry: for several decades, no new significant players have entered the industry, and all market power has been concentrated in the resources of the three leaders. The lack of new entrants as a result of the high threshold meets extremely low competitiveness, which ultimately leads to concentration of power, price fixation, and lower quality, that is, negatively affecting the consumer experience.
The Supply Problem
The outlined problem reflects supply issues since, in the event of a merger and anticompetitive effects, the merger will cause a supply modification in the market. The merged companies will undoubtedly begin to either produce new merged products or implement a Brand Proliferation strategy (Cheng & Tabuchi, 2020; Sinurat & Dirgantara, 2021). For the customer, this will lead to a change in the market supply in the short term. In the long term, if anticompetitive effects are taken into account, there will be a drop in the quality of the products produced and, therefore, a deterioration in the quality of supply, which may affect demand indicators.
References
Cheng, Y. L., & Tabuchi, T. (2020). First mover advantage by product proliferation in a multiproduct duopoly. International Journal of Economic Theory, 16(1), 106-118. Web.
Fathollahi, M., Harford, J., & Klasa, S. (2022). Anticompetitive effects of horizontal acquisitions: The impact of within-industry product similarity. Journal of Financial Economics, 144(2), 645–669. Web.
H.J. Heinz Company. (2001). Innovation: Annual report. Web.
Johnson, C. (2001). Heinz calls off the beech-nut merger. The Washington Post. Web.
Leary, T. B. (2001). An inside look at the Heinz case. FTC. Web.
Sinurat, W., & Dirgantara, I. M. B. (2021). The effects of brand equity, price, and brand proliferation on new product performance through product trial: evidence from FMCG industry in Indonesia. Diponegoro International Journal of Business, 4(1), 58-68. Web.
Sohani, M., & Dake, A. (2021). Mergers and acquisition: A tool to grow in the global market. Jus Corpus Law Journal, 2, 1344-1351.
Wang, X., Hu, F., Ren, Z., Fu, J., & Zhang, Y. (2019). Research on the collaborative development of the whole dairy industry chain based on industrial organization model optimization. Chinese Journal of Animal Science, 55(1), 137-141.