1 Knowledge Objectives Build on our understanding of related/unrelated diversification Understand the rationales, risks and rewards of acquisitions Understand

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Knowledge Objectives

• Build on our understanding of related/unrelated diversification

• Understand the rationales, risks and rewards of acquisitions

• Understand strategic alliance types, rationales, and governance– Vertical and horizontal alliances– Skill sharing, cost sharing, market entry

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Mergers and Acquisitions (some terminology)

• Merger:Merger: a strategy through which two firms a strategy through which two firms

agree to integrate theiragree to integrate their operations on a operations on a relatively co-equal basisrelatively co-equal basis

• Acquisition:Acquisition: a strategy through which one a strategy through which one firm buys a controlling interest in another firm firm buys a controlling interest in another firm with the intent of making the acquired firm a with the intent of making the acquired firm a subsidiary business within its own portfoliosubsidiary business within its own portfolio

• Takeover:Takeover: a special type of an acquisition a special type of an acquisition strategy wherein the target firm did not solicit strategy wherein the target firm did not solicit the acquiring firm’s bidthe acquiring firm’s bid

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Rationales for Acquisitions & Mergers?

• Industry Lifecycle (e.g., Whirlpool, Maytag)

• Technological Trajectories (e.g., Google, YouTube)

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Some notable acquisitions

• AOL acquired Time Warner for $164B (2003)

• eBay acquired Skype for $2.6B (2005)• Newscorp acquired MySpace.com for

$580M (2005)

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• Siemens AG (NYSE:SI) announced Tuesday it will acquire a 28% stake in Archimede Solar Energy S.p.A. Siemens indicated it may seek a majority stake in the Italian company. The deal expands the German industrial giant's presence in the solar power sector, where is the market leader in steam turbine generators for solar thermal power plants.

• ASE's technology made it an attractive target. The company is the sole producer of solar receivers that use molten salt rather than oil as the heat transfer fluid. Siemens says it can create more efficient solar thermal power plants by combining that technology with its own, positioning for what it believes will be heated demand for solar power over the next decade

Source: Deal.com 3/25/09

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Google bought YouTube ($1.65B in 2006)

AcquisitionsAcquisitions

Why?• Google bought a rival. • YouTube had four times as many hits as

Google Video• YouTube streamed nine times as many

clips as Google Video. • Google’s choice to buy rather than build

marked a big strategic change.(Economist, 10/14/06, p82).

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Google Acquires YouTube ??

• 1st – what industry is Google in?• 2nd – what is the Google “system”• 3rd – logic of the acquisition?

– YouTube=45% of video users

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Acquisitions

AcquisitionsAcquisitions = alternatives …to internal development of resources and capabilities

• PROBLEM: there is “no market” to price resources and capabilities – value depends on combination of acquirer and target; difficult to evaluate in advance (Barney, 1986).

• Acquirers pay large premiums over the eventual value of the targeted capabilities – though shareholders of targeted firms gain

• Acquiring firms fail to achieve strategic and financial objectives in a majority of cases.

• Difficulties in integrating distinct organizations and cultures frequently result in the destruction of the targeted capabilities (Madhok, 1997).

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Reasons for Making Acquisitions

IncreaseIncreasemarket powermarket power

OvercomeOvercomeentry barriersentry barriers

Cost of newCost of newproduct developmentproduct development Increase speedIncrease speed

to marketto market

IncreaseIncreasediversificationdiversification

Reshape firm’sReshape firm’scompetitive scopecompetitive scope

Lower risk comparedLower risk comparedto developing newto developing new

productsproducts

Learn and developLearn and developnew capabilitiesnew capabilities

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Google IndustryGoogle Industry

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Reasons for Making Acquisitions:

• Factors increasing market powerFactors increasing market power– Enables firm to sell goods or services above Enables firm to sell goods or services above

competitive levels of value;competitive levels of value;– Lowers costs of primary or support activities Lowers costs of primary or support activities

below those of its competitorsbelow those of its competitors– derived from how the size of the firm augments derived from how the size of the firm augments

resources and capabilities resources and capabilities

• Market power is increased byMarket power is increased by– horizontal acquisitionshorizontal acquisitions– vertical acquisitionsvertical acquisitions– related acquisitionsrelated acquisitions

Increase Market PowerIncrease Market Power

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• Barriers includeBarriers include– economies of scale (established competitors)economies of scale (established competitors)– differentiated products differentiated products – LT customer relationships that create product LT customer relationships that create product

loyalties with competitorsloyalties with competitors

• acquisition of an established company acquisition of an established company – Can be more effective than entering the market Can be more effective than entering the market

de novo, i.e., offering an unfamiliar good or de novo, i.e., offering an unfamiliar good or service service

– provides a new entrant with immediate market provides a new entrant with immediate market accessaccess

Overcome Entry BarriersOvercome Entry Barriers

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• Significant investments of a firm’s Significant investments of a firm’s resources are required toresources are required to– Develop new products internallyDevelop new products internally– introduce new products into the marketplaceintroduce new products into the marketplace

• Acquisition of a competitor may result inAcquisition of a competitor may result in– more predictable returns (near term)more predictable returns (near term)– faster market entryfaster market entry– rapid access to new capabilitiesrapid access to new capabilities

Product Cost & Speed to Product Cost & Speed to MarketMarket

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• Acquisitions to improve ST product Acquisitions to improve ST product portfolios are more easily valued, vs. portfolios are more easily valued, vs. those of LT product developmentthose of LT product development

• Managers may view acquisitions as Managers may view acquisitions as lowering risk in this area – why?lowering risk in this area – why?

Accelerate product Accelerate product developmentdevelopment

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• easier to develop and introduce new easier to develop and introduce new products in the firm’s current markets products in the firm’s current markets (shared resources)(shared resources)

• Lack of market/product knowledge makes Lack of market/product knowledge makes “organic” development difficult “organic” development difficult – uncommon for many firms to use internal uncommon for many firms to use internal

development for new products to diversify in development for new products to diversify in high tech.high tech.

– acquisitions are quick and easy way to diversify acquisitions are quick and easy way to diversify a firm and change its product/market portfolio a firm and change its product/market portfolio

DiversificationDiversification

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• use acquisitions to reduce dependence use acquisitions to reduce dependence on one or more products or markets on one or more products or markets (become a “generalist firm”)(become a “generalist firm”)

• i.e., reducing a company’s dependence i.e., reducing a company’s dependence on specific markets alters the firm’s on specific markets alters the firm’s competitive scopecompetitive scope

Competitive ScopeCompetitive Scope

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• Acquisitions may enable a firm to Acquisitions may enable a firm to learn learn – to gain capabilities currently – to gain capabilities currently unavailable to the firm unavailable to the firm

• Acquisitions may be used toAcquisitions may be used to– acquire a special technological capabilityacquire a special technological capability– broaden a firm’s knowledge basebroaden a firm’s knowledge base

– Overcome knowledge-based inertiaOvercome knowledge-based inertia (i.e., local search)

ExplorationExploration

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Problems With Acquisitions

IntegrationIntegrationdifficultiesdifficulties

InadequateInadequateevaluation of targetevaluation of target

Large orLarge orextraordinary debtextraordinary debt

Inability toInability toachieve synergyachieve synergy

OverdiversificationOverdiversification

Target firms preoccupied Target firms preoccupied with acquisitionswith acquisitions

Resulting firmResulting firmis too largeis too large

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– melding disparate corporate culturesmelding disparate corporate cultures– linking different financial and control linking different financial and control

systemssystems– building effective relationships (when building effective relationships (when

management styles differ)management styles differ)– resolving status of acquired firm’s resolving status of acquired firm’s

executivesexecutives– losing key personnel weakens firm’s losing key personnel weakens firm’s

capabilities and reduces value of acquisitioncapabilities and reduces value of acquisition

Integration DifficultiesIntegration Difficulties

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• Due diligenceDue diligence requires hundreds of issues be requires hundreds of issues be closely examined, includingclosely examined, including– financing the intended transactionfinancing the intended transaction– Cultural differences between acquirer and target Cultural differences between acquirer and target – tax consequences tax consequences – Organizational and incentive actions necessary Organizational and incentive actions necessary

to integrate human resourcesto integrate human resources

• Ineffective due-diligence Ineffective due-diligence – Results in excessive premiums for the target Results in excessive premiums for the target

companycompany

Inadequate Target Evaluation Inadequate Target Evaluation

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• Firm may take on significant debt to Firm may take on significant debt to acquire a company (LBO)acquire a company (LBO)

• High debt High debt – increases likelihood of bankruptcyincreases likelihood of bankruptcy– downgrades the firm’s credit ratingdowngrades the firm’s credit rating– Creates opportunity costs - precludes Creates opportunity costs - precludes

investment in activities that contribute to investment in activities that contribute to value creationvalue creation

Large DebtLarge Debt

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• Synergy exists when assets are worth Synergy exists when assets are worth more when used in conjunction with more when used in conjunction with each other than when they are used each other than when they are used separatelyseparately

• transaction costs (i.e., aligning incentive transaction costs (i.e., aligning incentive systems) attend acquisition strategies systems) attend acquisition strategies

• Firms underestimate indirect costs Firms underestimate indirect costs when evaluating a potential acquisitionwhen evaluating a potential acquisition

Inability to Achieve SynergyInability to Achieve Synergy

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• Increased diversification requires more Increased diversification requires more complex structures to interpret & complex structures to interpret & integrate information integrate information

• Increased scope created can cause Increased scope created can cause reliance on financial rather than reliance on financial rather than strategic controls to evaluate BU strategic controls to evaluate BU performance and potentialperformance and potential

• Acquisitions may become substitutes for Acquisitions may become substitutes for innovation (good or bad?)innovation (good or bad?)

OverdiversificationOverdiversification

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• Target firms may slow down or operate in Target firms may slow down or operate in “suspended animation” during an “suspended animation” during an acquisitionacquisition

• Executives may hesitate to make decisions Executives may hesitate to make decisions with long-term consequences until with long-term consequences until negotiations have been completednegotiations have been completed

• Acquisition process can create a short-Acquisition process can create a short-term perspective and a greater aversion to term perspective and a greater aversion to risk among top-level executives in a target risk among top-level executives in a target firmfirm

Acquisition UncertaintiesAcquisition Uncertainties

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• Additional bureaucratic costs can Additional bureaucratic costs can exceed the benefits of the economies of exceed the benefits of the economies of scale and additional market powerscale and additional market power

• Integrating larger targets = more Integrating larger targets = more bureaucratic controls bureaucratic controls

• controls can lead to rigid behavior / controls can lead to rigid behavior / reduced adaptation, sacrificing reduced adaptation, sacrificing innovation and responsiveness innovation and responsiveness

Too LargeToo Large

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Attributes of Effective Acquisitions

AttributesAttributes ResultsResults

Complementary Complementary Assets or ResourcesAssets or Resources

Buying firms with assets that meet current Buying firms with assets that meet current needs to build competitivenessneeds to build competitiveness

Friendly Friendly AcquisitionsAcquisitions

Friendly deals make integration go more Friendly deals make integration go more smoothlysmoothly

Careful Selection Careful Selection ProcessProcess

Deliberate evaluation and negotiations are Deliberate evaluation and negotiations are more likely to lead to easy integration and more likely to lead to easy integration and building synergiesbuilding synergies

Maintain Financial Maintain Financial SlackSlack

Provide enough additional financial Provide enough additional financial resources so that profitable projects would resources so that profitable projects would not be foregonenot be foregone

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Attributes of Effective Acquisitions

AttributesAttributes ResultsResults

Low-to-Moderate Low-to-Moderate DebtDebt

Merged firm maintains financial flexibilityMerged firm maintains financial flexibility

FlexibilityFlexibility Has experience at managing change and is Has experience at managing change and is flexible and adaptableflexible and adaptable

Sustain Emphasis Sustain Emphasis on Innovation on Innovation

Continue to invest in R&D as part of the Continue to invest in R&D as part of the firm’s overall strategyfirm’s overall strategy

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Technology Trajectory as an S-Curve (Foster, 1986)

• Slow initial innovation rate

• Accelerates until it reaches diminishing returns

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Over time, Standard Architectures Over time, Standard Architectures Destroy ValueDestroy Value

Reduce choiceReduce choicemass production reduces variety (e.g., any mass production reduces variety (e.g., any

color as long as it is black)color as long as it is black)

Diminish innovativenessDiminish innovativeness innovations confined to modular types as innovations confined to modular types as

“systemic” change is difficult to coordinate“systemic” change is difficult to coordinate

standards make it hard to collect rent from standards make it hard to collect rent from innovationinnovation

Enable monopoly rents (e.g., MS)Enable monopoly rents (e.g., MS)

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Technical Standards for Personal Computers

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TECHNOLOGICAL CHANGE AND INDUSTRY STRUCTURE:

MODULAR PRODUCTHORIZONTAL INDUSTRY

INTEGRAL PRODUCTVERTICAL INDUSTRY

Fine & Whitney, “Is the Make/Buy Decision Process a Core Competence?”

PRESSURE TO INTEGRATE

PRESSURE TO DIS-INTEGRATEORGANIZATIONAL

RIGIDITIES

HIGH-DIMENSIONALCOMPLEXITY

NICHE COMPETITORS

PROPRIETARY SYSTEM PROFITABILITY

SUPPLIERMARKET POWER

TECHNICAL ADVANCES

32Double helix view: communications industry (MIT CFP program)

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ComponentsComponents

RefineRefine

RedesignRedesign

Component linksComponent linksStableStable ChangedChanged

Hybrid Hybrid Autos Autos

Modularity, innovation, and Modularity, innovation, and Organizational EffectsOrganizational Effects

Adapted from Henderson & Clark, 1990

Electric Electric seatsseats

FWD vs. RWD FWD vs. RWD vs. All WDvs. All WD

Automobile Automobile cruise cruise controlcontrol

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Alternative to Acquisitions: Cooperative Strategy

• Cooperative strategy is a strategy in Cooperative strategy is a strategy in which firmswhich firms– work togetherwork together– to achieve a shared objectiveto achieve a shared objective

• Cooperating with other firms is a Cooperating with other firms is a strategy thatstrategy that– creates value for a customercreates value for a customer– exceeds the cost of constructing customer exceeds the cost of constructing customer

value in other waysvalue in other ways– establishes a favorable position relative to establishes a favorable position relative to

competitioncompetition

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Strategic Alliance

• A strategic alliance is a cooperative A strategic alliance is a cooperative strategy in whichstrategy in which– firms combine some of their resources and firms combine some of their resources and

capabilities to create a competitive capabilities to create a competitive advantageadvantage

• A strategic alliance involvesA strategic alliance involves– exchange and sharing of resources and exchange and sharing of resources and

capabilitiescapabilities– co-development or distribution of goods or co-development or distribution of goods or

servicesservices– Independent firms

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CombinedCombinedResourcesResources

CapabilitiesCapabilitiesCore CompetenciesCore Competencies

ResourcesResourcesCapabilitiesCapabilities

Core CompetenciesCore Competencies

ResourcesResourcesCapabilitiesCapabilities

Core CompetenciesCore Competencies

Strategic Alliance

Firm AFirm A Firm BFirm B

Mutual interests in designing, manufacturing,Mutual interests in designing, manufacturing,or distributing goods or servicesor distributing goods or services

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Types of Cooperative Strategies

• Joint venture: two or more firms create an Joint venture: two or more firms create an independent company by combining parts of independent company by combining parts of their assetstheir assets

• Equity strategic alliance: partners who own Equity strategic alliance: partners who own different percentages of equity in a new different percentages of equity in a new ventureventure

• Nonequity strategic alliances: contractual Nonequity strategic alliances: contractual agreements given to a company to supply, agreements given to a company to supply, produce, or distribute a firm’s goods or produce, or distribute a firm’s goods or services without equity sharingservices without equity sharing

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Business-Level Cooperative Strategies:

ComplementaryComplementaryAlliancesAlliances

• complementary strategic alliances complementary strategic alliances are designed to take advantage of are designed to take advantage of market opportunities by combining market opportunities by combining partner firms’ assets in partner firms’ assets in complementary ways to create new complementary ways to create new valuevalue– these include distribution, supplier these include distribution, supplier

or outsourcing alliances where or outsourcing alliances where firms rely on upstream or firms rely on upstream or downstream partners to build downstream partners to build competitive advantagecompetitive advantage

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Margin Margin

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Outbound Logistics

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SupplierSupplier

• vertical complementary vertical complementary strategic alliance is formed strategic alliance is formed between firms that agree to between firms that agree to use their skills and use their skills and capabilities in different stages capabilities in different stages of the value chain to create of the value chain to create value for both firmsvalue for both firms

• outsourcing is one example outsourcing is one example of this type of allianceof this type of alliance

BuyerBuyer

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Margin Margin

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Horizontal AllianceHorizontal AllianceBuyerBuyerPotential CompetitorsPotential Competitors

• horizontal complementary strategic alliance is formed horizontal complementary strategic alliance is formed between partners who agree to combine their resources and between partners who agree to combine their resources and skills to create value in the same stage of the value chainskills to create value in the same stage of the value chain

• focus on long-term product development and distribution opportunities

• the partners may become competitorsthe partners may become competitors• requires a great deal of trust between the partnersrequires a great deal of trust between the partners

BuyerBuyer

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• competition response strategic competition response strategic alliances occur when firms join alliances occur when firms join forces to respond to a strategic forces to respond to a strategic action of another competitoraction of another competitor

• because they can be difficult to because they can be difficult to reverse and expensive to operate, reverse and expensive to operate, competition response strategic competition response strategic alliances are primarily formed to alliances are primarily formed to respond to strategic rather than respond to strategic rather than tactical actionstactical actions

CompetitionCompetitionResponse AlliancesResponse Alliances


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• uncertainty reducing strategic uncertainty reducing strategic alliances are used to hedge against alliances are used to hedge against risk and uncertaintyrisk and uncertainty

• these alliances are most noticed in these alliances are most noticed in fast-cycle marketsfast-cycle markets

• alliance may be formed to reduce alliance may be formed to reduce the uncertainty associated with the uncertainty associated with developing new product or developing new product or technology standards (i.e., share the technology standards (i.e., share the risk of uncertain R&D investments)risk of uncertain R&D investments)


UncertaintyUncertaintyReducing AlliancesReducing Alliances


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• competition reducing strategic competition reducing strategic alliances may be created to avoid alliances may be created to avoid destructive or excessive competitiondestructive or excessive competition

• explicit collusion exists when firms explicit collusion exists when firms directly negotiate production output directly negotiate production output and pricing agreements in order to and pricing agreements in order to reduce competition (illegal)reduce competition (illegal)

• tacit collusion exists when several tacit collusion exists when several firms in an industry indirectly firms in an industry indirectly coordinate their production and coordinate their production and pricing decisions by observing each pricing decisions by observing each other’s competitive actions and other’s competitive actions and responsesresponses

Competition ReducingCompetition ReducingAlliancesAlliances




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• mutual forbearance is a form of mutual forbearance is a form of tacit collusion in which firms avoid tacit collusion in which firms avoid competitive attacks against those competitive attacks against those rivals they meet in multiple marketsrivals they meet in multiple markets

• competition reducing strategic competition reducing strategic alliances may require governments alliances may require governments to find ways to permit collaboration to find ways to permit collaboration among rivals without violating among rivals without violating antitrust lawsantitrust laws

Competition ReducingCompetition ReducingAlliancesAlliances




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Corporate-Level Cooperative Strategies

• Corporate-level cooperative strategies are Corporate-level cooperative strategies are designed to facilitate product and/or designed to facilitate product and/or market diversificationmarket diversification

- diversifying strategic alliancediversifying strategic alliancesynergistic strategic alliancesynergistic strategic alliance- franchisingfranchising

• Diversifying alliances and synergistic Diversifying alliances and synergistic alliances allow firms alliances allow firms

- to grow and diversify their operationsto grow and diversify their operations- through a means other than a merger or through a means other than a merger or

acquisitionacquisition

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Corporate-Level Cooperative Strategies:

DiversifyingDiversifyingAlliancesAlliances

• diversifying strategic alliance diversifying strategic alliance allows a firm to expand into new allows a firm to expand into new product or market areas without product or market areas without completing a merger or an completing a merger or an acquisitionacquisition

• provides some of the potential provides some of the potential synergistic benefits of a merger or synergistic benefits of a merger or acquisition, but with less risk and acquisition, but with less risk and greater levels of flexibilitygreater levels of flexibility

• permits a “test” of whether a future permits a “test” of whether a future merger between the partners would merger between the partners would benefit both partiesbenefit both parties

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Corporate-Level Cooperative Strategies:

• synergistic strategic alliances create synergistic strategic alliances create joint economies of scope between joint economies of scope between two or more firmstwo or more firms

• create synergy across multiple create synergy across multiple functions or multiple businesses functions or multiple businesses between partner firmsbetween partner firms

SynergisticSynergisticAlliancesAlliances

Synergistic AlliancesSynergistic Alliances

DiversifyingDiversifyingAlliancesAlliances

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International Cooperative Strategies

• Cross-border strategic allianceCross-border strategic alliance– an international cooperative strategy in an international cooperative strategy in

which firms with headquarters in different which firms with headquarters in different nations combine some of their resources and nations combine some of their resources and capabilities to create a competitive capabilities to create a competitive advantageadvantage

– a firm may form cross-border strategic a firm may form cross-border strategic alliances to leverage core competencies that alliances to leverage core competencies that are the foundation of its domestic success to are the foundation of its domestic success to expand into international marketsexpand into international markets

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Network Cooperative Strategies:

Stable AllianceStable AllianceNetworkNetwork

• long term relationships that often long term relationships that often appear in mature industries where appear in mature industries where demand is relatively constant and demand is relatively constant and predictablepredictable

• stable networks are built for stable networks are built for exploitationexploitation of the economies of the economies available between firmsavailable between firms

Stable Alliance NetworkStable Alliance Network

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Technological/market similarity and alliance governance

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Competitive Risks with Cooperative Strategies

CompetitiveCompetitiveRisksRisks

• Partner may act opportunistically Partner may act opportunistically • Misrepresentation of competencies brought Misrepresentation of competencies brought

to the partnershipto the partnership• Partner fails to make committed resources Partner fails to make committed resources

and capabilities available to its partnersand capabilities available to its partners• Firm may make investments that are specific Firm may make investments that are specific

to the alliance while its partner does notto the alliance while its partner does not

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Approaches for Managing Cooperative Strategies

• cost minimizationcost minimization– formal contracts specify how the cooperative formal contracts specify how the cooperative

strategy is to be monitored and how partner strategy is to be monitored and how partner behavior is to be controlledbehavior is to be controlled

• opportunity maximizationopportunity maximization– maximize partnership’s value-creation maximize partnership’s value-creation

opportunitiesopportunities– partners take advantage of unexpected partners take advantage of unexpected

opportunities to learn from each other and to opportunities to learn from each other and to explore additional marketplace possibilitiesexplore additional marketplace possibilities

– fewer formal, limiting, contractsfewer formal, limiting, contracts

Documents

1 Knowledge Objectives Build on our understanding of related/unrelated diversification Understand the rationales, risks and rewards of acquisitions Understand