The primary purpose of this assignment is to provide a detailed analysis of the proposed acquisition of Hitachi Global Storage Technologies by Western Digital Corporation. The deal was completed in March, 2012. Both companies operate in desktop hard disk market and were important market players when the acquisition proposal was made by Western Digital. This paper provides an industry analysis, market analysis, and presents arguments in favor of and against the proposed merger.
This section of the paper analyses the proposed acquisition of Viviti Technologies Ltd. (a wholly-owned subsidiary of Hitachi, Ltd.; formerly known as Hitachi Global Storage Technologies) by Western Digital Corporation. Acquisition proposal was made early in March, 2012, and the definitive agreement was reached on March 7, 2012. Both companies operate in desktop hard disk drives industry. This part of the paper offers analysis of the annual sales and extent of operations of the two companies in the merger. This section also offers some incentives to consolidate that are viable from the firms’ point of view. In addition, it offers a description of the product (production methods, a scale of production, and sources of raw materials) and technologies that are used for manufacturing. This section offers a description of the competitive environment within the industry, in particular, dominance within the industry and methods of competition. Finally, this section of the paper reports the 4 firm concentration ratio, the 8 firm concentration ratio, and the Herfindahl Hirschman Index for the industry as well as provides their interpretation.
Western Digital Corporation (NASDAQ: WDC) is one of the largest world manufacturers of computer hard disk drives. Founded in 1970, the company has its headquarters in Irvine, CA. The company is known for multiple innovations in hard disk manufacturing technology such as the development of ATA and introduction of the first SATA hard drive that operated at 10,000 rpm. The company operates worldwide and offers a three-year warranty on its products worldwide. In 2012, Western Digital earned $12.5 in terms of revenues. The corporation employs 96,000 people worldwide.
Hitachi Global Storage Technologies (HGST) was formed in 2003 as a merger of IBM and Hitachi hard disk manufacturing business. The company manufactures internal and external hard disk drives for laptops, desktop computers, servers, and other IT products. The company has a wide selection of products from 3.5-inch drives to cloud technologies. The company operates worldwide and sells its products through distributors such as Ingram Micro and Arrow Electronics. Its manufacturing facilities are located in the United States, Singapore, Thailand, China, and the Philippines.
There are several reasons why the two companies seek consolidation. The first reason is that Western Digital and HGST together comprise approximately 48% of the world’s HDD market by combined unit shipments. The proposed merger would form a company that would dictate the rules on the market. The second reason is that Hitachi was long seeking an opportunity to sell HGST because the division turned profitable only in the last two years. The third reason for merger would be a consolidation of manufacturing capacities that would result in economy of scale and cost reduction. This would result in greater efficiency of the merger company. The final reason is that WD wants to achieve a strong presence in the SSD market. HGST has an agreement with Intel that allows HGST to combine Intel’s SSD architecture with Hitachi’s HDD interfaces. If the proposed merger is successful, it would result in transferring the agreement to Western Digital and thus enabling the latter to introduce SSDs to the enterprise market.
A product market under analysis is the market for 3.5-inch hard-drive disks (HDD). It is a three and a half inch wide data storage device. It has one or more flat round platters that are coated with a specific material that is magnetically sensitive. These platters are located in a vacuum case which is also equipped with recording heads. The device is used for storing and retrieving electronic data. While such HDDs are made for various purposes, the primary area of commerce is the area of desktop HDDs. These hard drives are installed in non-portable computers (or desktop computers). Compared to other types of hard drives on the market, desktop HDDs offer the lowest price per gigabyte of storage space; this type of hard drives is also traditionally offering largest storage capacities (between 60 Gb and 4 Tb storage space). Other types of hard drives (such as 2.5-inch drives that are commonly installed in laptops) cannot be considered substitutes of the product under analysis since they are normally priced higher per gigabyte of storage space and have smaller storage capacities. They also have other features that distinguish them from desktop hard drives. For example, they are simply incompatible with the majority of computer motherboards that are installed in desktop computers. Hence, it would be impossible for customers to switch from 3.5-inch desktop hard drives to other types of storage devices in case the price for the former device increases. 3.5-inch desktop hard drives are manufactured in Asia using ferromagnetic materials, aluminum (also glass or ceramic) spindles, and two electric motors as primary components.
Hard disk manufacturing involves multiple methods. The primary part of a hard disk is data storage platter. The first step in its manufacturing process involves extracting minerals (such as platinum that has to be separated from other metals and aluminum). The second step involves producing aluminum blanks, which are disks made of aluminum alloy which the magnetic coating would be deposited on. The next step is coating those blanks with phosphorus and nickel alloy, which is applied through an electrolysis process. The following stage of the production process involves polishing the platter multiple times so that the resulting material has the minimum level of flatness. Before any magnetic recording layers are applied, the disk is washed in specific chemical solutions in order to ensure that it is free from any particles. Final stages of manufacturing include applying magnetic under-layers, adding data storage layers, applying a carbon overcoat that serves as a protective layer, and final testing. Hence, hard disk manufacturing is a complex process that calls for a wide selection of raw materials that have different origins. Since production is very concentrated due to an economy of scale, major events such as flooding in Taiwan in 2011 that caused a 28% decline in worldwide HDD shipments may be detrimental for the industry. Hence, companies may, on the one hand, seek concentration of production locations and, on the other hand, seek diversification to avoid major damage that may be caused by unforeseeable events on the major manufacturing sites.
Competitive Environment within the Industry
The desktop HDD market is highly concentrated. At present, worldwide HDD market is dominated by three companies: Seagate, Toshiba, and Western Digital. Prior to the proposed merger, the situation was slightly different. Nevertheless, as measured by the Herfindahl-Hirschman index (4,200) the market is highly concentrated: together, WD and HGST comprise two-thirds of the market and account for 48% of the sales, and post-merger HII would be 5,000. Thus, the merger would increase the industry’s Herfindahl-Hirschman index by 800. Considering the fact that there are only three primary competitors in the industry, it is not possible to analyze the market using CR4 (four-firm concentration ratio) and CR8 (eight-firm concentration ratio).
Prior to the proposed merger, HGST behaved as the strongest market player that continuously improved manufacturing technologies and product quality. In 2010, when the company finally became profitable, it also served as the key driver of price-based competition that prevented other market players from increasing prices of their products. Furthermore, this division of Hitachi announced expansion of its desktop hard drive business. Other market players (such as Samsung) could not retain competitiveness in the market. Thus, HGST acted as a constraint on potential price increases and would have acted as a constraint after Samsung merged with Seagate. To conclude, competition in the market under analysis is based on innovation, quality and prices for similar products.
This section of the paper presents two arguments for and against the proposed merger. The proposed merger is in favor of the firms, but not in the interests of the society at large. These arguments explain the importance of competition and provide an explanation of the upsides and downsides of competition among desktop hard-drives manufacturers. The two proposed arguments explain different benefits offered by competition in the desktop hard-drive industry to the society.
The argument in favor of the proposed merger. Dynamic efficiency is an important characteristic of the desktop HDD market. This is the industry where innovation is the driving force of the market. Hence, companies that operate in this market need a rate of return that would allow them to compensate for research and development expenditures. Hard disk manufacturing industry is a good example of creative destruction – a concept advocated by Schumpeter. In this industry, one generation of products is replaced by another. Therefore, the primary need for consolidation in the industry is to decrease production costs and free resources that are to be redirected into research and development. By joining their manufacturing capacities, HGST and WD can offer the market products that cost less to produce. With growing popularity of laptops and tablet computers, the primary customers of desktop hard drives are businesses that need significant storage space and can afford purchasing non-portable computers. Therefore, the consumer market is small and customers can negotiate the price of the final product, especially with bulk orders. Thus, companies like WD and HGST need to merge in order to decrease buyer’s power.
Other arguments in favor of consolidation may include the necessity to diversify risks that are posed by potential breakdowns at primary production locations. The consequences of flooding in Taiwan included substantial increases in prices of desktop hard drives. The risk may be eliminated through diversifying production locations. The proposed merger provides market players with an opportunity to do so.
The argument against the proposed merger. The proposed merger would result in substantial reduction of competition and lead to a creation of monopoly. Specifically, it may have several detrimental effects. First, it would lead to a substantial reduction of competition in the desktop hard-drive market, since the consolidated business would have more than 50% share of the discussed market. Second, it may result in a situation when market players decide to coordinate their actions and thus lead to a situation when consumers would be forced to pay higher prices for desktop hard drives. The consequences of the proposed merger can be characterized as violating competition conditions and, therefore, may be viewed as violating competition laws of the United States. In such a way, preserving competition conditions in the desktop hard drive market should be viewed as beneficial from the public interest point of view as based on the United States legislation.
From the economic point of view, the argument against the proposed merger is based on the notion that competition is beneficial for the hard-drive manufacturing industry. This claim can be supported by the following arguments. First, introduction of new products in the desktop HDD industry is characterized by cannibalization. This means that by introducing new products, hard drive manufacturers have to stop manufacturing old products and thus stop earning profits from them. Although computer hard drive manufacturers depend on manufacturers of other components (such as motherboards) in their innovation strategies, cannibalization is the primary factor that limits innovation activity of the established industry players. Although old industry players may have capital advantage when it comes to innovation costs, they cannot earn profits from the innovative products at once: they have to wait until manufacturers of other computer components adjust to their innovative addendum. Hence, allowing more firms to enter the industry would result in introduction of more technologically advanced products. This is simply because those new industry players would adjust to existing conditions faster and thus prevent lags in innovation.
The second argument in favor of competition is that established industry players face high costs of innovation primary because of organizational inertia. While companies that operate in hard drive manufacturing may have accumulated certain research and development capital (they all have well-established research centers), it may also be the case that in order to introduce a certain technological breakthrough, these companies need significant amounts of time due to structural complexities.
Thus, maintenance of the oligopolistic structure of the desktop hard drive manufacturing market provides for the establishment of common standards for all products that are sold in the market. On the one hand, this is beneficial for the society, since consumers are exposed to a selection of substitutes and businesses have a wider range of target consumer segments. However, this effect of oligopoly is positive only in the short run. In the long run, companies that have been in the market for long are not investing in innovation, since changing the standards for the products sold in the market automatically means becoming a niche player that serves a small market segment, which is technologically advanced to purchase innovative hard drives that are incompatible with existing motherboards. Therefore, negative effects of oligopolistic market structure outweigh positive effects of product standardization. Thus, high market concentration in case of the desktop hard drive market is a threat to the consumers.
To conclude, the proposed acquisition of Hitachi Global Storage Technologies by Western Digital Corporation was found to be a threat to consumers of desktop hard-drive disks. The proposed acquisition was likely to violate competition legislation of the United States and create an undesirable situation on the market. A more complex analysis of the industry revealed that existing market players were unlikely to invest in innovative technologies under oligopolistic market conditions. Thus, final consumers suffered in the absence of competition. Establishment of the common standards on the desktop hard disk market was concluded to be a threat to the consumers.
Price fixing is a violation of the Clayton Antitrust Act that should be understood as a deliberate agreement among competitors that establishes prices for goods or services at particular levels that are believed to be most beneficial for the agreeing parties. Sometimes price fixing does not involve several companies; rather, it may be the case that a single company abuses its dominant market position and engages into price fixing by using various methods.
In 1998, Federal Trade Commission banned Toys ‘R’ Us, Inc., a nationwide toy retail chain to manipulate the toy market in the United States by restraining competition and maintaining artificially high prices for its products. In particular, the 1998 FTC order prohibits the retailer from pressuring its suppliers and urging them to limit supplies of toys to any discount sellers (such as Costco or Sam’s Club) or even refuse to sell similar toys to discounters. The order also prevents the company from requesting any information concerning sales to discounters from any of its suppliers. The decision was made after in 1996 the company was accused of keeping prices higher and restricting toy choices for its customers through manipulating its suppliers.
However, in 2011 Toys ‘R’ Us, Inc. violated the decision made by FTC in 1998. Through its subsidiary, Babies ‘R’ Us, the company attempted to fix prices for strollers, high chairs, car seats, and other goods for babies. The company is believed to have pressured its suppliers from 1999 to 2010. In addition, it repeatedly requested information concerning sales to discounters from its suppliers. This type of behavior was prohibited by the 1998 FTC order. Hence, the company was required to pay $1.3 million penalty, since the order was to be in effect for twenty years after it was issued.