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ARCHIVES | 1988

By CLAUDIA H. DEUTSCH

The case study method of teaching business requires students to study a corporation and suggest ways to solve its problems. This article takes the same approach, but with a twist: The
subject is the proposed Philip Morris-Kraft merger, and the ''students'' - in this case, professors, executives, analysts and consultants - were asked to predict the results.
Less than a week ago, the hottest topic in the food industry - and on Wall Street - was Grand Metropolitan's $5.2 billion bid for the Pillsbury Company. Now it is all but forgotten,
dwarfed in both size and interest by what is happening at the huge tobacco-cum-food companies. On Monday, the Philip Morris Companies made a surprise $11.5 billion bid for the
Kraft Company. And three days later, RJR Nabisco Inc. became the target of a proposed $17 billion leveraged buyout by an investor group led by its own executives.
In terms of size, the RJR deal dwarfs both of the others. But in terms of potential impact on the food industry, the Philip Morris-Kraft merger would raise the most dust. If the
RJR buyout goes through, the result will probably be a smaller company, as the investors sell off pieces to service their debt. But if Philip Morris lands Kraft - and there are few people
betting against it - the merged company will be a $37.6 billion behemoth.
Through its General Foods subsidiary, Philip Morris already owns such brands as Maxwell House coffee, Jell-O and Birds Eye frozen foods. The Kraft acquisition would give it a
huge dairy presence as well, with such well- known brands as Breyer's, Sealtest, Breakstone's and Miracle Whip. The combined company would be the world's largest consumer goods
company, displacing Unilever, the British-Dutch giant that, at $27.1 billion in sales last year, seemed to have a lock on the top spot.
The prospect makes some economists bemoan what they see as yet another nail driven into the coffin of anti-trust enforcement. To others, it means that the American food
industry is finally recognizing that, to compete with foreign giants in global markets, it must be much more concentrated than it now is.
But once the hoopla has died down, will the merger make a difference to anyone other than Philip Morris and Kraft shareholders?
Probably not, at least in the short term. Kraft is a profitable company, and Hamish Maxwell, Philip Morris's chief executive, has a reputation for leaving well enough alone.
Indeed, he has already promised that he will not break up Kraft, fire its employees, or even move its headquarters from Illinois to New York, Philip Morris's home.
The combined company will certainly have formidable clout among supermarkets. But then, General Foods and Kraft, with their many brands, exert heavy influence in their own
right. Their product lines do not overlap much, so the merger is unlikely to yield production economies. The merged company will have a powerful distribution network, particularly
for fresh foods, but few food industry executives expect that will have any sort of anticompetitive effect. Even small supermarket chains, which are very dependent on big
manufacturers for cooperative advertising and price promotions, do not expect much change. ''The merger just won't have much impact,'' said Oscar A. Smith Jr., owner of Community
Foods Inc., a $37 million chain in Baltimore.
The one group that seems likely to be affected most by the merger - and, in fact, by any merger of this size - is the management service industry. Combined companies do not need
more than one accounting firm, and often whittle down the number of advertising agencies, outside law firms, and executive recruiters that they use. Executive recruiters, in fact, are
particularly hard hit by megamergers, in that the ethics of their profession prevents them from recruiting candidates from companies they already work for. That sort of arrangement
is usually worked out on a case-by-case basis. But if Philip Morris wants to, it can probably make General Foods and Kraft off-limits to any recruiter with whom it does business. That
would severely hamper that recruiter in doing a search for, say, Campbell Soup or Heinz.
Right now, academicians, food industry executives and service-sector people are pondering the ramifications of a combined Philip Morris and Kraft. Following are some of their
early conclusions. Herbert M. Baum: President, Campbell USA.
I'm tickled pink that this is happening. The biggest food conglomerates were Nestle and Unilever, and they are both foreign. The combination will give us an American- owned
food company that would be the biggest of them all. I'm chauvinistic about America, and that makes me feel good.
And it doesn't really change anything as far as competition goes. There was absolutely no difference in the marketplace when Philip Morris took over General Foods. And General
Foods and Kraft are so big anyway that I can't see how it would make a difference in supermarket clout.
If they keep the two companies separate managerially, then really nothing has changed. And if they do try to combine them somehow, it would take them two years before the
executives could even find their new offices.
That doesn't mean the merged company will not be an awesome competitor. Over the last three, four years Kraft has acquired a lot of food service distributors, and that is a
strength that really supplements General Foods as it pushes into refrigerated products. If they have more trucks going to more stores and can get there faster than us, we'll have a
problem. But then, Philip Morris had fresh foods distribution already, through its Oscar Meyer subsidiary's business in deli meats. And we are in the bakery business, through
Pepperidge Farm, so we understand the fresh foods mentality, too.
Food industry consolidation is good for the consumer. You tend to think that the lessening of competition drives prices up. Not in food. Manufacturers like us throw our
marketing dollars at in-store promotions and price reductions. Well, the bigger the company, the more dollars it has to throw against price reductions. And even if their combined
dollars drove other American companies out of, say, the frozen dinner business, the Japanese or the Koreans or some European country will find a way to come here and do it cheaper.
The global economy will force these companies to keep prices low. It's been predicted for years that someday there will be four or five food companies in the U.S. I don't think that's
bad. Two would be bad; five or six would not.
I wouldn't want to see Washington try to stop this merger. Not many of their products overlap, so it isn't minimizing competition in any one area of the store. And after all, we
may be in a position someday to buy someone very big. Walter Adams: Professor of economics, Michigan State University, and author of ''The Bigness Complex.''
During the Reagan Administration the antitrust laws have been subjected to a systematic policy of euthanasia. That is certainly true of the antimerger law, the Clayton Act, Section
7, which simply hasn't been enforced. We're seeing corporate marriages between and among the Fortune 500, and that means that corporate dinosaurs are free to roam the Darwinian
jungle.
There is an opportunity cost to playing the merger game. It is in the form of factories that are not built, R. & D. that was not done, jobs that were not created. A merger doesn't
create any new values, any new real capital. It consists of an exchange of pieces of paper on the floor of the New York Stock Exchange.
From the point of view of building a strong American economy, this sort of merger seems little short of madness. Companies spent the 1960's buying up other companies, and the
1980's divesting the companies they bought. So today Philip Morris acquires Kraft, and 10 years later it says oops, that was a mistake, we'll get rid of Kraft. What has been done for the
American economy?
There is a theory of antitrust that says don't take any action unless there are predatory practices. That's wrong. The mere presence of a giant in a field will intimidate existing
competitors and discourage potential new competitors. We prohibit people from carrying submachine guns in the street; we don't wait for them to shoot someone. That's why in 1967
the Justice Department wouldn't let Procter & Gamble buy Clorox.
The way to fight the Japanese and the newly industrialized countries is to build state-of-the-art facilities that can stand on their own feet. We see this in the steel industry. Time
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 mini-mills have said they don't need protection from foreign mills; the giants, presumably efficient because of their size, have been asking for ''temporary'' protection since 1968.
The Philip Morris-Kraft merger will send a signal to the corporate community that it can continue merging to its heart's content, that the cop on the beat is looking the other way,
even though a strong American economy may require that we do exactly the opposite of playing the merger game. Katheryn R. Harrigan: Director of Strategy Research Center,
Columbia Business School.
I don't think such mergers are bad for the American economy at all. The antitrust laws as they were interpreted historically may no longer be correct. In 1890 we were a growing
economy; today, we are a mature industrialized economy, operating in a global environment. So what constitutes monopoly now? You have to define the boundaries beyond the
continental United States.
And all of the European companies are over here with their shopping carts now, frantic over 1992 and looking to acquire American companies. These guys have deep pockets and
patient capital. And if we have too much foreign ownership, ultimately, the innovation, the knowledge creation will occur someplace else. We don't want to become a nation of drones;
we want the thinkers within our boundaries.
Companies like Philip Morris can see it coming, and that's why they are getting together now. Industries like food still have a lot of restructuring to do. There are too many firms
doing the same thing to be effective at moving food from the farm through processing and to the stores, particularly on a global basis. Mergers like this improve allocated efficiency. I
don't think we're having a significant loss in the choice of vendors, so we are still offering consumers a choice. But if you are more efficient you can pay better wages to employees, and
keep prices from going up too much.
This is not just economy of scale, this is economy of scope. It is natural for a food company to want many brands in its portfolio so it can catch every little nuance that the
customer wants. If it can deal with just a few suppliers and distributors yet sell a large number of brands, it can get product to consumers at lower prices. Lynn Tendler Bignell:
Principal, Gilbert Tweed Associates.
Every time there is a merger, competition for business becomes more intense, because there are fewer clients to go after, and fewer companies to recruit from. We need to cover
our backs a lot more than we had to in the past. You see a lot of recruiters turning into full-service human resources consultants, at least partly in hopes of strengthening the bond with
the client so that if the client is acquired, this one firm will be a survivor.
Off-limits policies are a problem for any recruiter. I don't understand how specialty practices are going to survive in a climate of megamergers. If a company - and there are several
- specializes in recruiting, say, consumer products marketing people, then every big merger means fewer companies from whom to recruit. And a merger like this one can be a real
problem for anyone who has assignments from Philip Morris or General Foods or Kraft.
This kind of megamerger changes the competitive picture for generalist recruiting firms. In the past, the big firms mainly recruited high-priced talent for and from huge
companies. But with mergers putting so many companies on their off-limits list, their ability to sell themselves as useful resources to large companies is growing limited. So they are
going after small companies, after the not-for-profit sector, after all the niche markets that smaller firms used to have to themselves.
But in one sense the whole mergers and acquisitions trend has been good for all of us. Executives have no idea who will own their company tomorrow, and that has made all of
them far more receptive to headhunters' calls than they were in the past. John M. McMillin: Food industry analyst, Prudential-Bache.
Consolidation is a very healthy trend in the food industry. Unless your name is Paul Newman, you can't get into the supermarket anymore without spending $100 million to
develop a new brand and push into new categories. To compete effectively you have to be big.
The beauty of the food companies used to be that they sold to a highly fragmented industry. But there have been a lot of supermarket mergers. And supermarkets have been
gaining power over the food companies via scanners and ways they can measure profitability per square foot. Food mergers like this one might again place the leading food
manufacturers in a position of dominance. The merged companies will be able to get the shelf space they want, often without paying slotting allowances, payments they often have to
make just to get products on the shelf.
This merger again signals the value of No. 1 brands today. The value of a steady earnings stream has increased and nothing gives a steady earnings stream like a good consumer
brand. And a steady earnings stream is what you need to make debt payments.
This merged company will have close to 10 percent of the $230 billion domestic food industry. And, since Kraft dominates that all-important refrigerated foods sector of the
supermarket, this merger will make General Foods strong not only in the dry and frozen part of the supermarket, but in the refrigerated part too. More than 40 percent of Kraft's
earnings came from refrigerated products, and that's where the world is moving. This gives General Foods the distribution system it needs in that sector.
This is an industry where only the strongest can survive, and those companies with No. 1 brands and leading positions will increasingly see higher returns. This is an environment
where the strongest get stronger and the weak get weaker. Combining these companies just accelerates a trend that already exists. Kenneth Peskin: Chairman and chief executive,
Supermarkets General Corporation.
In the retail business, we have to look at everything from the perspective of our customers. And do you think most of them really know that Philip Morris owns General Foods? My
suspicion is, no. What customers are interested in is brands like Maxwell House or Philadelphia cream cheese.
There really is no way this merger will be harmful to those brands. If it turns out just to be a big financial deal, its impact will be neutral. But Philip Morris is spending an awful lot
of money buying Kraft, and it's going to be driven to get a return for that money. Well-known brands give the best returns, and I think Philip Morris will encourage more product
innovation and more aggressive marketing of brands. Kraft is already a good company, and now it is likely to offer even better support to retailers, in the form of assistance with
displays, guaranteed freshness of products and such. And I love the idea of Kraft helping General Foods distribute some of its products.
I've heard people talk about how such huge companies can force retailers to give them better shelf space, or how big retail chains can threaten food suppliers with taking their
goods off the shelves. The idea that a retailer can say it is not going to stock a brand that the customer wants is ridiculous. And the idea that General Foods or Kraft or any combination
of the two will make us think that our relationship with them is more important than our relationship with the customer is equally silly.
In fact, I think the merged company will be responsive to retailers' suggestions. We are strong believers that everything sold in a store ought to be freshness-dated, and that tricky
coupons - ones where the customer has to write things in to get a discount - don't make sense. I think they'll listen to us now, because they have so much at stake.
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A version of this article appears in print on October 23, 1988, on Page 3003001 of the National edition with the headline: CASE STUDY: The Philip Morris-Kraft Merger; Why Bigness May Not Matter.

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