Strategic Management/ Business Policy

Strategic Management/ Strategic Management/ Business PolicyBusiness Policy

Joe Mahoney

Corporate Level StrategyCorporate Level Strategy

A corporate-level strategy is an action taken to gain a competitive advantage through the selection and management of a mix of businesses competing in several industries or product markets.

What businesses should the firm be in?How should the corporate office manage its group of businesses?

Corporate Level StrategyCorporate Level Strategy

Vertical IntegrationStrategic AlliancesDiversification (corporate portfolio management)

To add value, a corporate strategy should enable a company,or one of its business units, to perform one or more of the value creation functions at a lower cost, or in a way which supports a differentiation advantage. Corporate strategy is the way a company creates value through the configuration and coordination of multi-market activities.

Vertical IntegrationVertical IntegrationDefining Vertical Integration

The number of stages in a product’s or service’s value chain that a particular firm engages in defines that firm’s level of vertical integration.

• Forward integration: When Coca-Cola began buying its previously franchised independent bottlers.

• Backward integration: When Home Box Office began producing its own movies for screening on the HBO Cable Channel.

Understanding the Value Chain

Raw Materials

Manufacturing

Distribution

Backward Integration

Forward Integration

Diversification

Vertical Scope of the Firm 20

Voigt, Fall, 1998

(1) In determining whether activities should be internal or external:

Summary: Creating Value in Vertical Activities

(2) In coordinating these activities along the value chain:

ExternalCustomer

Internal ActivitiesExternal Supplier

Be Better Than Competitors

Vertical IntegrationVertical Integration

Why vertically integrate?

Market Powerentry barriersdown stream price maintenanceup stream power over price

Efficiencyspecialized assets & the holdup problemprotecting product qualityimproved scheduling

Transactions Costs and theScope of the Firm

Transactions Costs and theScope of the Firm

Which is more efficient : several specialist firms linked by markets, or the combination of these specialist firms under common ownership.

VERTICAL PRODUCT GEOGRAPHICAL

AREAS

SINGLE V1 P1 P2 P3 A1 A2 A3

FIRM V2

V3

SEVERAL V1 P1 P2 P3 A1 A2 A3

SPECIALIZED V2

FIRMS V3

Common Issue--- What are TRANSACTION COSTS of markets compared with administrative costs of the firm?

Vertical IntegrationVertical Integration

In order to avoid confusion on the vertical coordination problem it is important for the manager to separate two distinct issues:

Issue #1: What is the objective for vertical coordination? Or put differently, what efficiencies, risk sharing, or market power advantages are being sought?

Issue #2: What organizational form (e.g., vertical contracts, equity joint ventures, mergers & acquisitions) best achieves the desired objective(s)?

Managerial Eco. - Rutgers University 6-13

Optimal Input Procurement

Substantial specialized investments relative to contracting costs?

Spot ExchangeNo

Complex contracting environment relative to costs of integration?

Yes

Vertical Integration

Yes

Contract

No

Types of strategic alliance

Strategic alliances

Non-equity allianceCooperation between firms is managed directly through contracts without cross-equity holding or an independent firm being created

Joint VentureCooperating firms form an independent firm in which they invest. Profits from this independent firm compensate partners for this investment

Equity allianceCooperative contracts are supplemented by equity investments by one partner in the other partner. Sometimes these investments are reciprocated

Network-BasedOrganizations

Expediting MultidisciplinaryCommunication

NetworkNetwork--BasedBasedOrganizationsOrganizations

Expediting MultidisciplinaryExpediting MultidisciplinaryCommunicationCommunication

ElectronicNetworksElectronicElectronicNetworksNetworks

FormalNetworks

FormalFormalNetworksNetworks

InformalNetworksInformalInformalNetworksNetworks

© McGraw Hill Companies, Inc., 2000

Structuring the Alliance to Reduce Opportunism

Opportunism by partnerreduced by:

Seeking crediblecommitments

Agreeing to swapvaluable skills

and technologies

Establishingcontractual safeguards

Walling offcritical technology

Figure 14.1

14-21

DiversificationDiversificationDiversification Issues

1. Motives for diversification2. Mode of diversification3. Measurement of diversification

Motivations For DiversificationMotivations For Diversification

Value Enhancing Motives:

Economies of Scope (shared activities to reduce costs)Transferring Core Competencies (Leveraging)Brand-name that is exportable (e.g., Haagen-Dazs to chocolate candy)R&D and new product developmentUtilizing excess capacity (e.g., in distribution)

Motivations For DiversificationMotivations For Diversification

Value Enhancing Motives:

Developing New Competencies (Stretching)Efficient ManagementFinancial Motives

internal capital allocation & restructuringrisk reductiontax advantages

Increase market powermulti-point competition

Other Motivations For Diversification:Other Motivations For Diversification:

Motivations that “Devaluate”:Growth maximization

managerial capitalism/agency problemprotect against “unemployment risk”maximize management compensation

Motivations that are “Value neutral”:Diversification motivated by poor performance in current businesses.

DiversificationDiversification

Issue #1: There may be no value to stockholders in diversification moves since stockholders are free to diversify by holding a portfolio of stocks.

Issue #2: When there is a reduction in managerial (employment) risk, then there is upside and downside effects for stockholders.


On the upside, managers will be more willing to learn firm-specific skills that will improve the productivity and long-run success of the company (to the benefit of stockholders).

On the downside, top-level managers may have the incentive to diversify to a point that is detrimental to stockholders.


No one has shown that investors pay a premium for diversified firms -- in fact, discounts are common.

A classic example is Kaiser Industries that was dissolved as a holding company because its diversification apparently subtracted from its value.


No one has shown that investors pay a premium for diversified firms -- in fact, discounts are common.

Kaiser Industries main assets: (1) Kaiser Steel; (2) Kaiser Aluminum; and (3) Kaiser Cement.

These were independent companies and the stock of each were publicly traded. Kaiser industries was selling at a discount which vanished when Kaiser industries revealed its plan to sell its holdings.

MODE of diversificationMODE of diversification

Choice of mode of diversification:

Internal developmentAcquisitionJoint ventureLicensing

34

Relationship Between Firm Relationship Between Firm Performance and DiversificationPerformance and Diversification

IncentivesIncentives

ManagerialManagerialMotivesMotives

ResourcesResources DiversificationDiversificationStrategyStrategy

FirmFirmPerformancePerformance

InternalInternalGovernanceGovernance

StrategyStrategyImplementationImplementation

Capital MarketCapital MarketIntervention and theIntervention and theMarket forMarket forManagerial TalentManagerial Talent

The BCG MatrixThe BCG Matrix

Cell 1: Stars Cell 2: Question Marks

Cell 3: Cash Cows Cell 4: Dogs

High

High

Low

Low

Industry Industry Growth RateGrowth Rate

Relative Market ShareRelative Market Share

© 1999 Pankaj Ghemawat

Investmentand

Growth

High

High

Low

Low

Medium

Medium

Selectivity

Harvest/Divest

Harvest/DivestSelectivity

Selectivity

Industry Attractiveness B

usin

ess

Str

engt

h

SelectiveGrowth

SelectiveGrowth

Harvest/Divest

Harvest/Divest

Harvest/Divest

The Industry Attractiveness-Business Strength Matrix

Mergers and AcquisitionsMergers and Acquisitions

Increasing use of mergers & acquisitions

1980s: 55,000 M&As: total value $1.3 trillion1998: total value $2.5 trillion1999: total value $3.4 trillion

IN UNITED STATES:1998: total value $1.6 trillion1999: total value $1.75 trillion


A merger is a strategy through which two firms agree to integrate their operations on a relatively co-equal basis because they have resources and capabilities that together may create a stronger competitive advantage.


An acquisition is a strategy through which one firm buys a controlling or 100 percent interest in another firm with the intent of using a core competence more effectively by making the acquired firm a subsidiary business within its portfolio.


A takeover is a type of an acquisition strategy wherein the target firm did not solicit the acquiring firm’s bid.

Ch7-3

Problems inAchieving Success

Problems inProblems inAchieving SuccessAchieving Success

IntegrationIntegrationdifficultiesdifficulties

Inadequate Inadequate evaluation of targetevaluation of target

Too muchToo muchdiversificationdiversification

Large orLarge orextraordinary debtextraordinary debt

Inability toInability toachieve synergyachieve synergy

Managers overlyManagers overlyfocused on acquisitionsfocused on acquisitions

Too largeToo large

IncreasedIncreasedmarket powermarket power

OvercomeOvercomeentry barriersentry barriers

Lower riskLower riskcompared to developing compared to developing

new productsnew products

Cost of newCost of newproduct developmentproduct development

Increased speedIncreased speedto marketto market

IncreasedIncreaseddiversificationdiversification

Avoid excessiveAvoid excessivecompetitioncompetition

AcquisitionsAcquisitions

Reasons forReasons forAcquisitions Acquisitions


Reasons for AcquisitionsIncreased Market Power• e.g., BP Amoco attempt to acquire Arco

Overcome Entry Barriers• e.g., entry into international markets

Lower Cost of New Product Development• e.g., pharmaceutical companies frequently

use acquisitions to gain access to new products


Reasons for Acquisitions

Increased Speed to Market• e.g., BMW’s acquisition of Rover

Diversification• e.g., Seagram’s acquisition of Universal Studios

Avoiding Excess Competition• e.g., General Electric’s acquisition of NBC

Mergers and AcquisitionsMergers and AcquisitionsProblems with Acquisitions

Integration Difficulties•e.g., Pillsbury and Burger King

Inadequate Evaluation of Target•e.g., Bridgestone acquisition of

Firestone

Large or Extraordinary Debt•e.g., Campeau’s acquisition of

Federated Stores

Mergers and AcquisitionsMergers and AcquisitionsProblems with Acquisitions

Inability to Achieve Synergy•e.g., AT&T and NCR

Overly Diversified•e.g, GE -- prior to refocusing

Overly Focused on Acquisitions•e.g., Conglomerates of 1960s

20

Attributes of Effective Attributes of Effective AcquisitionsAcquisitions

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

21

Attributes of Effective Attributes of Effective AcquisitionsAcquisitions

AttributesAttributes ResultsResults

LowLow--toto--Moderate 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

Sustainable Competitive AdvantageSustainable Competitive Advantage

Trying to gain sustainable competitive advantage via mergers and acquisitions puts us right up against the “efficient market” wall.

If an industry is generally known to be highly profitable, there will be many firms bidding on the assets already in the market. Generally the discounted value of future cash flows will be impounded in the price that the acquirer pays. Thus, the acquirer is expected to make only a competitive rate of return on investment.


And the situation may actually be worse, given the phenomenon of the winner’s curse.

The most optimistic bidder usually over-estimates the true value of the firm.


Under what scenarios can the bidder do well?

(1) Luck;

(2) Asymmetric information

– This eliminates the competitive bidding premise implicit in the “efficient market hypothesis”

(3) Specific-synergies between the bidder and the target.

– Once again this eliminates the competitive bidding premise of the efficient market hypothesis.

Restructuring ActivitiesRestructuring Activities

Downsizing

Wholesale reduction of employees• e.g., General Motors cuts 74,000 workers and

closes 21 plants

Downscoping

Selectively divesting non-core businesses• e.g., Break-up of AT&T into three businesses in

1995

Restructuring Activities -- LBOsRestructuring Activities -- LBOs

Purchase involving mostly borrowed fundsGenerally occurs in mature industries where R&D is not central to value creationHigh debt load commits cash flows to repay debt, creating discipline for managersIncreases concentration of ownershipFocuses attention of management on shareholder value

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Strategic Management/ Business Policy