BazermanMoore

The Competitive Escalation Paradigm 107
The same is true of the earlier scenario involving Companies A, B, and C. In 1995,
the basic pattern of this story played out with American Airlines, United Airlines, and
USAir. USAir, the nation’s fifth-largest airline, announced in 1995 that it was for sale at
the right price. Analysts quickly speculated that the two industry leaders, United and
American Airlines, were likely to be interested. However, their analyses were limited to
the expectation that the value of USAir was higher to United or American as an acquisition
than as a stand-alone company. These analyses ignored information suggesting
that United and American would be extremely motivated to avoid losing a bidding war,
since the sale of USAir to American would be a major setback for United, and the sale
of USAir to United would be a similarly damaging blow to American. As the head of
American or United, what would you do?
American developed a strategy aimed at avoiding the escalatory war described
above. Robert Crandall, the chairperson of American, wrote an open letter to his company’s
118,000 employees that stated:
We continue to believe, as we always have, that the best way for American to increase its
size and reach is by internal growth—not by consolidation.... So we will not be the first to
make a bid for USAir. On the other hand, if United seeks to acquire USAir, we will be
prepared to respond with a bid, or by other means as necessary, to protect American’s
competitive position (Ziemba, 1995).
Although the letter was addressed to American Airlines employees, it was obvious
that the most important target of this message was United. The message was
clear: Keep things as they are, or we will both end up in a money-losing battle.
Crandall’s letter was effective in avoiding an escalatory war (no offers were made
on USAir in 1995). Five years later, when United made a preemptive bid on USAir
for 232 percent of the company’s stand-alone value, both United and American
stock prices fell sharply.
Failing to learn from Crandall’s successful strategy, Johnson & Johnson (J&J) got
into a bidding war for Guidant, a medical products manufacturer. J&J began with a bid
of $25.4 billion for Guidant in December 2004 (Feder, 2006). Initially, this appeared to
be a profitable deal for both Guidant stockholders and for J&J. About six months later,
however, before the deal closed, the New York Times uncovered a scandal involving
one of Guidant’s products. For three years, Guidant had failed to tell doctors that its
implantable defibrillator contained a flaw that caused it to malfunction in some
instances. The FDA opened an investigation into Guidant, and soon the company had
announced a product recall of its defibrillator.
In fall 2005, J&J indicated that it wanted to renegotiate the terms of its deal with
Guidant, citing concerns about the federal investigation and Guidant’s ‘‘short-term results
and long-term outlook’’ (Feder & Sorkin, 2005). New York Attorney General Eliot
Spitzer announced a lawsuit against Guidant, on the same day that the FTC conditionally
approved the J&J/Guidant merger. J&J chose not to execute the deal, and Guidant
sued J&J to force the acquisition (Feder, 2006). As negative press surrounding
Guidant mounted (Meier, 2005), J&J entered a revised $21.5 billion bid for Guidant on
November 16.