Comparing Against The Market
The acquisition of Cleveland based TRW Inc. by defence company Northrop Grumman Corp. (Los Angeles) was characterised by a variety of features and events that made the takeover particularly interesting. The most obvious element of interest that should be pointed out is that the merger was hostile. Indeed the deal concluded on July 1, 2002 (although the final watchdog approval came on December 10, 2002) ended “a bruising five-month battle.”
The intricate evolution of events contributed to the build up of suspense and hence peculiarity of the deal. Northrop had to raise its bid three times before placing its final all stock offer valuing TRW at $60 a share. During its agonising takeover, Northrop had to fight TRW’s techniques to defend their company as well as competing against other bidders seeking TRW. Additionally, Northrop was particularly interested in TRW’s aerospace and information systems units but not in TRW’s key automotive business. This complicated the deal as Northrop also had to take into account how to spin-off the unwanted business while venturing in the takeover.
Another interesting feature which was quite surprising was redundancy. While a typical merger often implicates cost savings and thus inevitably reducing the workforce, the Northrop-TRW merger actually increased the overall workforce. Indeed Northrop’s CEO Kent Kresa wanted to reassure on this point: “Northrop said it had no plans to lay off TRW workers in Southern California, because there is little overlap. Kresa said that with the country focused on beefing up homeland security and military, employment at TRW facilities in the area could grow.”2 A final remark that should be made regarding the interesting traits of the takeover is that the whole deal was much a surprise.
Prior to the TRW deal, Northrop was actively engaged in acquiring other companies. In 2001 it had acquired Newport News Shipbuilding and Litton Industries Inc, public belief was that it would take a while for Northrop to digest these mergers, but surprisingly, on February 22, 2002 Northrop stroke again. It should also be noted that 2002 was a particularly quiet year for merger activity, hence this deal further surprised the public.
2.1 Timeline of Events 2.2 Company Description The following section briefly describes the two companies involved in the deal and the activities in which they endeavour. 2.21 Thompson-Ramo-Wooldridge (TRW Inc.) The company’s main activity were to provide advanced technology products and services. The group was also into research and performance of system engineering. It used to operate in four segments, namely: Automotive, Systems, Space ;Electronics and Aeronautical systems. The operating facilities of the Group were located in 25 different countries. The customers of TRW Inc included U.S Government, Department of Defence, NASA and major car manufacturers.
Northrop Grumman Corp. The Group’s principal activity is to assemble and sell innovative products, services and solutions in defence and commercial electronics. The Group operates in the Electronic Systems, Ships, Information Technology, Integrated Systems, Mission Systems and Space Technology sectors. The Electronic systems segment manufactures defence electronics and systems and airspace management systems.
The IT segment provides advanced information technologies, systems and services. The Integrated systems segment produces airborne early warning, electronic warfare and battlefield management systems. Ship systems products include sealift transport ships and double-hulled oil tankers. Mission Systems integrates complex, mission-enabling systems for government, military and business clients. Space Technology develops a range of systems at the leading edge of space, defence and electronics technology.4
U.S Aerospace & Defence – The sector explored The defence industry is strikingly atypical for a variety of reasons. Unravelling the sector is going to be crucial in order to understand the merger and to assess it later on. The defence business is far from a perfectly competitive one. In fact, it lacks almost all of the traits of perfect competition. Indeed, “defence is driven by non economic forces.”
Rather, it is influenced by socio-political events such as wars and terrorist attacks. Interestingly, it is one of the few industries that behaves adversely to the market. This is due to the fact that the population perceives the events that boost this industry (and we should say, not unjustly) as negative incidents (e.g. September 11th ), likely to influence negatively on the overall economy. Additional explanations relating to the inconsistency of defence to the overall performance of the economy are to be searched in the assumptions underlying perfect competition.
First of all, an obvious, but paramount feature: “it is about the only large sector that sells almost exclusively to governments.”6 The number of sellers too, is highly limited and the few firms that operate are extremely large and powerful. This leads to firm collusion and arbitrary control of price, making it hard for new competitors to enter the market. “Defence is a bit like cottage industry, says Sir Richard, in that the number of customers is small, everybody knows everyone else and everything is connected. “If Vance (Coffman of Lockheed) is in London, I’d be upset if he doesn’t call round for a cup of tea”, he says.”
Further, “in defence contracts are few but huge, and customers are few but powerful, so market forces do not work. “Defence is not normal.”8 This point is particularly relevant as it depicts a fundamental requirement for a company to succeed in obtaining contracts from the Government. That is: It must be large in order to provide an entire range of products. This should be understood in the light of transaction costs. Imagine how many companies the Government would have to appoint in order to supply them with the entire range of weapons they require, if the degree of product specialisation would be high (as it would with very small firms).
The search, negotiation and bargaining costs would be very high. A better option would be to have a smaller selection of suppliers that could provide them with all their needs. Clearly, these are not the best conditions for freshly started small businesses or firms seeking organic growth. On the contrary, weak firms are likely to be taken over by larger further whom are seeking growth or catching up upon their major peers. This is eloquently summed up in the figure below taken from a special report in the economist.
Retaining a knowledge of the main competitive forces and their weighting within the U.S defence industry is a crucial requirement for appreciating the rationale for the merger. It will also provides us with a benchmark to measure success. That is, comparing gains in market share will give us a powerful tool to evaluate the takeover. The table below provides data regarding the division of market share (prior to the takeover) between the major companies in the sector. Data is given for both the defence sector in particular and the overall aerospace and defence industry. This market share is calculated as a percentage of the total sales of the selected companies for the sector/industry. The charts that follow visually illustrate the information.9