19 March 2008
To understand consolidation it is useful to learn from the experiences of the consolidation of the US and Scandinavian rental markets. The US market is interesting because it is the largest rental market in the world and has recently undergone a huge consolidation in which the consolidators in the aftermath have experienced difficulties. These difficulties have ranged in the full spectrum from economic difficulties to filing for chapter 11 protection. The US consolidation is also quite well documented. The Scandinavian market is interesting because of being the most consolidated market in the world and hosts the most international rental companies.
Consolidation is defined here as the process of increased concentration of companies within an industry. I have used the aggregated market share of the three largest companies within a market as a measure of the degree of consolidation (CR3). Secondly, we view consolidation from the point of a company that drives the consolidation which is labelled a consolidator.
I will examine three areas of consolidation: the context or drivers of consolidation (why); the process of consolidation (how); and the actual and realised benefits of consolidation (what has actually been achieved).
The consolidation of the rental industry differs significantly between markets. The most consolidated markets identified are the Scandinavian, particularly the Swedish and Finnish markets, with a CR3 in the magnitude of 60%. Despite the great consolidation of the US rental market in the late 90s it is still only a moderately consolidated market (CR3=20%) which is a status shared by the UK market (CR3=20%) despite the high rental penetration. On a European level, the rental industry is highly fragmented and, as Gerard Déprez of Loxam wrote in an earlier article in IRN, it N can be disputed if Europe can even be classified as a single market.
In terms of internationalisation only the Scandinavian rental companies and niche rental companies like Aggreko are truly international. For instance, Ramirent has 80% of its revenues outside its domestic market and less than 25% of revenues in any given national market. The average rental consolidator, however, is either purely domestic or has less than 20% of the turnover outside the domestic market.
Drivers and context
There are, of course, several drivers of consolidation but there are only a small number that really matter.
Individual visions: A very important and often overlooked driver of consolidation is the individual vision of a leading CEO. Brad Jacobs drove the US consolidation as a new entrant, based on the success of his successful consolidation run in the US waste industry. His vision or belief seems to have been that the success could be repeated in another industry with similar basic conditions; he chose to consolidate the rental industry. Errki Norvio drove the Scandinavian consolidation with the aim to finance the Eastern European market entry and development, a decision made already in the late 80s.
Internal and external drivers: The global increase in rental penetration is an important driver as this makes the rental industry a growth industry, which attracts capital. In addition the industry also attracts capital as the investments can be leveraged, not just against a firm's ability to produce cash flow, but also against hard, long-terms assets. Risk management by being in several different markets with lags in the economic cycle is also put forward as a driver of consolidation on an international scale.
On industry level, the rental industry benefits from being structured with a distinct market leader powerful enough to set bench mark pricing and operational standards. The required market share to reach this status seems to be a market share in the magnitude of 30% and above. Being capital intensive, the rental industry is sensitive to downturns in the economical cycle, which is why a structured conduct is beneficial for the industry profitability. There are also external agendas of external stakeholders, like suppliers vertically integrating into the rental industry, which drives consolidation on industry level (e.g. Caterpillar and Atlas Copco).
On an organisational level growth is the most important driver. The value of an organisation is based both on the profitability and the growth. If a consolidator stops growing the value related to the growth is gone. Scale economies are another driver. With size an organisation has the opportunity to become more advanced and professional and is thereby able to better to meet the demands of large national or multinational customers, and also gains the ability to handle the risk of entering new markets or product segments.
The process of consolidation is an evolution that happens in steps, moving from national to regional (multinational) to continental and global levels. Consolidation is an on-going process with short periods of intense activity with longer periods of recovery and fine tuning in between. In Scandinavia the consolidation has moved from national to regional, while in the US consolidation is still at the national level. The last consolidation wave in the US lasted for two years in the end of the 90s and it is only now that some signs of a potential new consolidation wave are starting to show.
There are three pre-requisites for a consolidation wave to start. The first is a need for an imbalance on the market, like an economic shock or market disturbance. Second, there must be available capital to fuel the consolidation wave, and last there must be a driver of the consolidation, like Brad Jacobs or Errki Norvio. Another important fact is that consolidation is a process based largely on mergers and acquisitions (M & A), as organic growth is too slow, too expensive and adds capacity into an industry that is sensitive to over capacity, particularly in downturns.
Within a market the consolidation simplified follows a pattern of four stages; the opening stage; the scale stage with roll-ups and acquisitions; the focus stage with mega deals and huge mergers and the balance stage where there are only a few remaining consolidators and mergers are not an option. By moving from one level to another-for example, from national to regional, the consolidation process can slide down to an earlier stage within the new context and the consolidation race may start all over again.
From an organisational perspective a successful consolidator needs to develop not only a competitive business model. This model must also support consolidation and rapid growth.
With the help of external advisors a seller of a company should be able to calculate the value of the company in its current state. Without adding any value into the acquired company the acquirer will at best break even, but most likely lose money given that the seller does not sell below market value; the seller has a information advantage; and because the buyer faces the ‘winner's curse’ (that is, having to overpay to ‘win’ in a situation of competing bids).
The business model of the consolidator must therefore have the ability to add something into the acquired company to leverage the value. The model of course has to be competitive in order to generate cash flow to afford the expansion, but also be committed and adapted to handling rapid growth.
The organisation must posses a systematic acquisition and integration process and have the necessary resources allocated in-house.
Without the ability to find the right targets and to integrate this target, a successful business model will not be enough. The value of the acquisition will be lost due to the lack or only limited synergies and/or the inability to realise the potential synergies and benefits related to the acquisitions. United Rentals and GE are two organizations that have successfully integrated acquired companies with the commonality of having advanced integration processes and resources in-house.
The organisation must develop the ability to pay the right price
It seems obvious, but in reality a lot of the benefits end up with the seller. The acquisition process in itself may generate enough momentum due to the efforts put into the process by key decision makers that the deal will happen, despite not being rational. Also, the organisation must be able to calculate the true value of the target on its own and the value as part of the consolidator. A controversial but very relevant issue is that the synergies should belong completely to the consolidator as the seller does not have any or limited risks once the deal is closed. Just by looking at the multiples paid at different times for an organisation reveals the difficulties of paying the right price-that is, not overpaying.
An organisation need to develop the timing and know-how of when to go international
The rental business is a high commitment business in all the markets where an organisation does business. The distribution network of depots must be dense and cannot be placed outside the market, as in manufacturing. Also, a highly centralised business model, fine-tuned to the domestic market, may become a liability once going international. To become international adds the requirement of local responsiveness which must be balanced with centralised efficiencies. The transition for a successful organisation from a highly centralised business model to model with local responsiveness has proven to be difficult for many.
There are many views on the benefits related to the consolidation; as a consolidator you must know which are true and valuable and have the ability to realise these benefits. Becoming international adds a dimension of potential benefits but also adds a dimension of complexity. Right is a table with the most important potential benefits of consolidation and becoming international.
The most important benefits are related to scale economies; purchasing power; getting a structured conduct within the industry with a distinct pricing leader; a dense distribution network as competitive advantage and barrier to entry; public awareness of the industry including the industry becoming more attractive to qualified staff; and the ability to afford international expansion and/or add new product segments.
Benefits from national differences are getting the right prices in all markets and risk management by gaining the ability to transfer equipment between markets with lag in the economic cycles. Scope economies relate to gaining the ability to create geographically and logistically optimal clusters by disregarding national borders, and the potential to develop a broader and deeper product range to better meet the requirements of the customers.
Consolidation is a very difficult and complex process, even in a low-tech service industry like rental. The basic requirement to be successful is to be informed. To be informed means that you have to get at least eight critical success factors right; if you miss out even one, history tells us that you will be punished.
The eight critical success factors that I have come up with do not constitute a 'quick fix methodology'. To the contrary, they show the difficulties and the necessary efforts and competence needed to become a successful consolidator. The eight critical success factors are:
THE DRIVERS OF CONSOLIDATION (WHY) 1. Develop a vision to get a clear view of what is to be achieved. 2. Identify the drivers that really matter and use them to you advantage.
THE PROCESS OF CONSOLIDATION (HOW) 3. Know and master the mechanisms of industry consolidation. 4. Develop a business model that supports consolidation and is competitive relative to the market that it is going to operate in. 5. Develop a systematic acquisition and integration model and allocate the necessary resources in house. 6. Develop the ability to pay the right price when acquiring, i.e. have a tight (as in low) pricing strategy. All synergies belong to the consolidator. 7. Know when and how to make the transition from being domestic to an international company. THE BENEFITS OF CONSOLIDATION (WHAT HAS BEEN ACHIEVED) 8. Identify what the real benefits are and make sure that you are able to realise these benefits successfully.IRN