Et Tu, Aetna?

What a difference ten months makes! In October 2015, after United Health announced its intention to minimize its participation in the online exchanges of the Affordable Care Act (ACA), Aetna vowed to continue its participation in them. Its CEO Mark Bertolini declared, “We view it still as a big opportunity.”

So how long did his view last? Not even a full year! Last week, Aetna reversed its position and announced its intention to follow United’s withdrawal strategy.

Why? Aetna claimed that, after reviewing its recent fiscal data, its executives decided that the firm could no longer afford the costs of care for members inside the ACA exchanges. And yet the insurance giant had previously announced that it had “achieved record annual operating revenue and operating earnings in 2015, and delivered full-year operating EPS that was above (its) most recent projection.” And they produced these results while participating in the exchanges.

Furthermore, Aetna had threatened the federal government that it might withdraw from ACA exchanges if regulators failed to approve its mega-merger proposal with Humana. After the Department of Justice refused to approve the merger, Aetna announced its exchange withdrawal plans.

For obvious reasons, some critics charge that Aetna’s withdrawal represented a decision to “make good” on an inappropriate threat. Whether or not you believe that the insurer acted appropriately, though, it might be helpful to ponder a more fundamental question.

Namely, why should we believe that any large, for-profit health insurer would remain committed to the ACA exchanges? Indeed, why would such firms find it profitable to sell policies to individuals at any time?

Think about it. Large health insurers were never eager to sell affordable policies to individual families before the ACA was passed into law. That’s why individuals who were unable to access health benefits through their employers were often forced to purchase extremely limited plans with very large premiums.

Then and now, major health insurers prefer to contract with large employers that maintain Departments of Human Resources. These Departments employ teams of professionals to help insurers manage their administrative and communications responsibilities with their enrollees, i.e. with corporate employees.

Thus, insurers can achieve significant economies of scale by insuring many employees through each group contract. They cannot possibly achieve such cost efficiencies in the individual market.

So was there ever any reason to believe that the ACA would alter this fundamental economic reality? It’s hard to understand why any large national insurer would maintain a long term commitment to the individual market under any regulatory system.

Of course, this doesn’t necessarily mean that the exchanges should be shut down immediately. For the eleven million individuals who obtain health insurance through the ACA each year, an insurance policy with a non-profit or small for-profit insurer is undoubtedly preferable to no insurance policy at all. Such insurers may remain interested in growth strategies that rely on the individual policy market.

Nevertheless, ACA supporters who are excoriating Aetna for its withdrawal decision may wish to hold their fire. Whether or not they have a point about the ethicality of Aetna’s choice, it may be difficult for them to dispute the inevitability of it.

The Airlines: What Free Market?

Did you know that a mega-acquisition in the airline industry was just announced last week? It’s a transaction that will create the fifth largest passenger carrier in the United States.

Under normal circumstances, such an announcement would blast across the headlines. The federal government would launch a massive anti-trust review. And business pundits would rush to opine on the extent to which the transaction would impede market competition.

So why didn’t any of these events occur? Perhaps it is because we aren’t experiencing a normal competitive environment in today’s airline industry. After all, there are now only four mega-carriers left in the market. And according to the Associated Press:

“At 40 of the 100 largest U.S. airports, a single airline controls a majority of the market … (and) at 93 of the top 100, one or two airlines control a majority of the seats,”

Thus, even though last week’s announced acquisition of Virgin America by Alaska Airlines would create America’s fifth largest carrier, the post-acquisition entity would be so much smaller than the Big Four that the transaction would wield very little impact on the market.

In fact, there is so little competition that even the recent collapse in fuel prices has done little or nothing to encourage start-up airlines to begin serving smaller cities. When the major carriers pulled out of numerous mid-sized communities several years ago, they blamed soaring fuel prices for making small airplanes (with their limited ticket selling potential) uneconomical.

One would thus presume that the recent fuel price decline would result in a return to these smaller markets. But given the hammer-lock that the Big Four airlines possess over the flying public, there has been little or no such activity.

So the next time you hear an airline executive praise the virtues of a deregulated economy, you might choose to absorb such comments with a grain of salt. After all, in order to experience the benefits of a free market, one much first establish and maintain a condition of competitive balance. In today’s airline industry, though, competition appears to be in very short supply.

Sadie Hawkins Day For Fiat Chrysler

Have you ever heard of Sadie Hawkins Day? A fictional holiday that first appeared in the comic strip L’il Abner, it is the day when single men must run and hide from women.

Why? Because, according to tradition, any woman who catches a man on that day is legally entitled to wed him, whether he wishes to be married or not.

The image of weak and delicate women chasing down strong and powerful men spawned decades of humorous tales in the comic strip. In the business world, though, mergers and acquisitions are usually proposed by large corporations that seek to gobble up smaller competitors, and not the other way around.

And yet that hasn’t been the case for Fiat Chrysler, itself a relatively unusual alliance that was formed in an awkward shotgun marriage during the depths of the global economic crisis of 2008/09. The Italian-American firm has been conspicuously flirting with the much larger General Motors in pursuit of a merger.

Last week, though, GM head Mary Barra firmly rebuffed its embrace. Her rationale? General Motors is progressing with its own corporate turnaround strategy, and shouldn’t be diverted by opportunities that will only produce increases in absolute size. Most industry analysts agree that, except for the inevitable growth that would result from a merger with (or acquisition of) Fiat Chrysler, General Motors would achieve no other significant benefits.

It is interesting, though, that so many recently proposed corporate mega-mergers appeared to offer no benefits, other than increases in size. Did its recently consummated merger with US Airways, for instance, truly improve American Airlines in any other manner? Or would its recently discontinued merger proposal with Time Warner have truly improved Comcast in any noticeable fashion? It is quite difficult to name any business benefits of such consolidations at all, except for those that would result from the elimination of market competition.

Thus, even though Ms. Barra has been castigated for GM’s recent legal difficulties, it might be appropriate to praise her for avoiding a corporate marriage to Fiat Chrysler. By making this choice, Ms. Barra is likely improving GM’s long term prospects and the health of the competitive marketplace at the same time.

Assuming, of course, that Fiat Chrysler CEO Sergio Marchionne decides to drop his amorous pursuit of his far larger rival. If he should continue to pursue a merger or acquisition, Ms. Barra might be well advised to maintain a very low profile …

… especially on Sadie Hawkins Day.

Break Up The Techs!

You’ve heard the cry break up the banks, haven’t you? Politicians like Senator Elizabeth Warren of Massachusetts continue to press the argument that our global banks are too large, too diversified, and too complex to continue in their present forms.

If that’s what they assert about the global banks, though, what would they say about our global technology companies? Just last week, the telecommunications giant Verizon bought internet pioneer AOL for $4.4 billion. And at roughly the same time, Facebook announced its entry into the business of publishing original news stories.

Why are firms like General Electric and Citigroup shedding their non-core businesses and shrinking down to their core competencies, while others like Verizon and Facebook expand aggressively beyond their fundamental services? Most proponents of expansionary strategies offer the justification that seemingly unrelated businesses can be aggregated in order to recognize underlying synergies.

On the other hand, the potential for synergies was the driving force behind AOL’s ill-fated merger with Time Warner. That 2001 transaction, executed just ahead of the bursting of the millennium era technology bubble, is often judged to be one of the worst merger decisions in business history.

So how are firms to know when diversification is a sound strategy? And how are they to judge when it is a foolhardy one?

There’s never a foolproof way to know the answers to such questions with absolute certainty. Nevertheless, it’s easy to understand why Verizon believes that it can strengthen the revenue potential of its telecommunications backbone by integrating AOL’s online advertising function. And, likewise, it’s a cinch to envision Facebook expanding its online market share by leveraging its existing platform to publish news stories.

Conversely, it’s difficult to envision how GE’s ownership of NBC Television could have helped it sell more jet engines. And it’s hard to argue that Citigroup’s ownership of a Japanese retail bank network could have helped it expand in the United States.

So, at least in retrospect, we appear to be quite capable of differentiating between sound and foolhardy expansion strategies. Regrettably, though, it appears to be far more difficult to proactively foresee such results.

Comcast, Time Warner, And Antitrust Law

Last week, America’s largest cable television provider Comcast announced that it is acquiring its biggest rival Time Warner Cable. The resulting merger of the nation’s two greatest cable television customer networks will establish Comcast as a dominant firm in nineteen of America’s twenty largest markets. It will also bequeath Comcast with 30 million customers, 50% more than the 20 million customers served by its closest competitor DirecTV.

You would think that a merger of the top two organizations in an industry, a transaction that leaves the surviving firm with a dominant market position over its remaining rivals, would be scrutinized carefully by antitrust regulators … wouldn’t you?

Well … think again! The transaction is expected to receive relatively little government scrutiny because cable television firms negotiate exclusive franchise arrangements for their customer markets. According to Comcast’s acquisition announcement, “Importantly, the proposed transaction will not reduce competition in any relevant market. Comcast and Time Warner Cable do not currently compete to serve customers in any zip code in America.”

So although Comcast competes against telephone companies that offer television services (like Verizon’s Fios and AT&T’s U-verse), as well as satellite communication companies that do the same (like DirecTV and Dish Network), Comcast does not directly compete against Time Warner Cable (or Cox Cable, or Cablevision) in its established service areas.

Because of its non-competitive franchise agreements, Comcast can benefit from the manner in which American antitrust laws have been written and enforced during the past century. Indeed, it has been that long since President Theodore Roosevelt first signed and then wielded antitrust legislation to “bust up” the great trusts of the late 1800s and early 1900s.

The laws tend to prohibit corporate acquisitions that would eliminate direct competition between firms in the short run. However, they tend to permit acquisitions that would help organizations build dominant market positions in the long run.

That’s why Comcast isn’t even bothering to suggest that the economies of scale to be achieved through industry consolidation may result in lower customer prices. Comcast’s Executive V.P. told reporters “We’re certainly not promising that customer bills are going to go down or even that they’re going to increase less rapidly.”

It is undoubtedly reasonable to argue that, under certain circumstances, the two largest organizations in an industry sector should be permitted to merge with each other. But if antitrust law in the United States is written and applied in a manner that precludes significant scrutiny of such mergers, how will American society be able to maintain the competitiveness of its markets?

If you were Edith Ramirez, the Commissioner of the Federal Trade Commission, would you petition the United States Congress to pass antitrust legislation that revises the criteria for regulatory reviews of proposed acquisitions? 

HP: Goodbye Personal Computers, Hello Services!

Do you remember when basketball legend Michael Jordan announced his retirement shortly after winning his third consecutive world championship with the Chicago Bulls? Or when football Hall of Fame quarterback John Elway retired after leading his Denver Broncos to their second consecutive Super Bowl win?

Quitting “on top,” while occupying the champion’s position, has been an admirable tradition of professional sports figures for many years. It is, however, far more unusual for leading businesses to walk away from their own dominant market shares.

Nevertheless, that is exactly what market share leader Hewlett Packard (HP) recently announced it would do in the personal computer business. And Michael Dell, founder and CEO of HP’s closest rival, did nothing to disguise his glee.

Call It Compaq

To be fair, HP never claimed to maintain a longstanding tradition in the personal computer industry. In fact, the Silicon Valley icon has always focused more intensively on test equipment, servers, calculators, printers, and similar devices.

In 2001, though, then-CEO Carly Fiorina authorized HP’s purchase of Compaq, the world’s second largest personal computer company. That allowed the newly combined HP-Compaq entity to leap-frog Dell and become the market leader. HP and Dell then shared the top two spots in the global personal computer industry from 2003 to 2010 (except for 2009, when Acer briefly nudged past Dell to snare the #2 position), and have engaged in a spirited rivalry throughout that time.

That explains Michael Dell’s bit of biting sarcasm when HP surprised the world by announcing that it would sell or spin off its personal computer business. Dell “tweeted,” via a posting on his public Twitter page, the following sardonic suggestion: “If HP spins off their PC business….maybe they will call it Compaq?”

The IBM Thinkpad

Although it is indeed highly unusual for a firm with the leading share of a market to voluntarily sell or spin off its business, HP’s move is somewhat reminiscent of IBM’s decision to sell its once-dominant Thinkpad personal computer division to Lenovo in 2005. In each situation, a successful computer manufacturer concluded that it could optimize profits by refocusing on service lines of business instead of on manufacturing activities.

In a broader sense, this strategy is reflective of the general shift from a manufacturing (and agricultural) economy to a service economy in the United States. Other iconic American manufacturing firms, such as Kodak to Xerox, have implemented similar initiatives.

Are these firms following sound business strategies? And are they helping, or hurting, the American economy and the prosperity of its citizens?

Shifting To Services

The financial accounting model is arguably constructed in a manner that leads investors to favor service organizations over manufacturing firms. That is because manufacturers often need to borrow significant amounts of capital to invest in the construction of buildings and the purchase of equipment; on the other hand, service firms can simply and cheaply utilize human labor (or, even more profitably, automated programs and other functions) to earn revenues.

By avoiding large investments in long term assets, service firms tend to post higher Return On Investment (ROI) and Return On Asset (ROA) statistics. Such performance measurements are closely tracked, and highly valued, by professional investment advisers.

This distinction explains why corporations from Marriott to McDonald’s have shifted from property ownership contracts to franchising and management service contracts over time. IBM, and now HP, appear to have adopted this strategy too.

Can America Prosper?

Although individual corporations can improve their financial results by shifting away from manufacturing activities, can entire nations do so as well? Can America and other nations continue to prosper if they surrender their capabilities to produce tangible goods?

America was once the dominant global manufacturing powerhouse; in fact, it still rivals China for the position of the world’s largest manufacturer. But the American service sector outgrew its manufacturing sector during the late 1950s; today, the service economy is more than twice the size of the manufacturing economy in terms of GDP.

Meanwhile, America has prospered for over half a century while undergoing a long term evolution from the manufacturing sector to the service sector. And although the American financial services industry continues to exhibit weakness, other service industries — such as health care, for instance — are expected to display strong growth well into the future.

The Hamburger vs. Facebook

America’s service sector employees are occasionally caricatured as burger flippers, working for minimum wage at fast food outlets. However, its service economy also encompasses software programmers who are admired around the world; many Egyptians, for instance, publicly thanked Facebook and Google for their roles in facilitating their successful political revolution.

It is always painful, of course, for nations to watch domestic manufacturing industries lose market share to foreign competitors. Nevertheless, firms like HP may indeed find success by aggressively shifting to service offerings, and may yet lead the American economy back to prosperity by doing so.