Copyright © 2004 South-Western. All rights reserved.7–1 Tuesday, April 22, Main Issues Portfolio matrix tools - recap What methods might firms use to become diversified? What is the difference between a merger and an acquisition? Who is most likely to make money from “M&A” activity? Why do firms pursue M&A? What are the problems associated with M&A? What is the difference between downsizing and downscoping? Which is generally best? What can we conclude about diversification?

Copyright © 2004 South-Western. All rights reserved.7–2 Acquisitions and Restructuring Strategies “modes of entry” into new lines of business acquisitions, mergers, takeovers restructuring/retrenchment - downsizing Vs. downscoping leveraged buy-outs (LBOs) Porter’s “3 Tests” for diversification decisions

Copyright © 2004 South-Western. All rights reserved.7–3 Figure 1.1 Copyright © 2004 South-Western. All rights reserved. The Strategic Management Process

Copyright © 2004 South-Western. All rights reserved.7–4 “Mode of Entry” = means by which firms enter new lines of business 3 primary “modes” of entry - 1. Start-up own business operation (develop competencies) 2. Acquire an existing business operation (buy competencies) 3. Joint venture/strategic alliance (share competencies)

Copyright © 2004 South-Western. All rights reserved.7–5 Start-Up as a Mode of Entry - Typically the least common method - WHY? Disadvantages of this mode of entry? Any advantages of this mode of entry?

Copyright © 2004 South-Western. All rights reserved.7–6 Joint Venture/Strategic Alliance as Modes of Entry - Increasingly common as a mode of entry Advantages = Disadvantages =

Copyright © 2004 South-Western. All rights reserved.7–7 Acquisition as a Mode of Entry - Numerous major varieties of acquisition: horizontal acquisition = vertical acquisition = related acquisition = unrelated acquisition = acquisition vs. merger vs. takeover =

Copyright © 2004 South-Western. All rights reserved.7–8 Acquisitions Cost new product development/increased speed to market Increased diversification Increased market power Avoiding excessive competition Overcoming entry barriers Learning and developing new capabilities Lower risk compared to developing new products Reasons for Acquisitions and Problems in Achieving Success Adapted from Figure 7.1

Copyright © 2004 South-Western. All rights reserved.7–9 Acquisitions: Increased Market Power Factors increasing market power  When firm can price above competitive levels  When costs of primary or support activities are below those of competitors  Often related to firm size, providing more resources and capabilities to compete  Horizontal, vertical, or related acquisitions Acquisitions intended to increase market power are subject to:  Regulatory review  Analysis by financial markets

Copyright © 2004 South-Western. All rights reserved.7–10 Acquisitions: Overcoming Entry Barriers ENTRY BARRIERS increase the expense and difficulty faced by new ventures trying to enter that market, such as ... Cross-Border Acquisitions -

Copyright © 2004 South-Western. All rights reserved.7–11 Acquisitions: Cost of New-Product Development and Increased Speed to Market Internal development of new products is costly and time-consuming The resulting new products may flop!  Acquisitions allow a firm to gain access to new and current products that are new to the firm  Returns are more predictable because of the acquired firms’ experience with the products

Copyright © 2004 South-Western. All rights reserved.7–12 Acquisitions: Lower Risk Compared to Developing New Products An acquisition’s outcomes can be estimated more easily and accurately than the outcomes of an internal product development process Managers may view acquisitions as lowering risk

Copyright © 2004 South-Western. All rights reserved.7–13 Acquisitions: Increased Diversification A relatively quick way to change a firm’s “portfolio” of businesses Both related diversification and unrelated diversification strategies can be implemented through acquisitions The more related the acquired firm is to the acquiring firm, the greater is the probability that the acquisition will be successful

Copyright © 2004 South-Western. All rights reserved.7–14 Acquisitions: Learning and Developing New Capabilities An acquiring firm can gain capabilities that the firm does not currently possess In the long term, the acquirer needs to gain capabilities, not just new products Firms should acquire other firms with related and complementary capabilities in order to build their own knowledge base

Copyright © 2004 South-Western. All rights reserved.7–15 Acquisitions: Reshaping the Firm’s Competitive Scope An acquisition can:  Reduce the negative effect of an intense rivalry on a firm’s financial performance  Reduce a firm’s dependence on one or more products or markets Reducing a company’s dependence on specific markets alters the firm’s competitive scope or domain

Copyright © 2004 South-Western. All rights reserved.7–16 Acquisition track record - who benefits most? Stockholders of the acquiring firm? Stockholders of the acquired firm? Others?

Copyright © 2004 South-Western. All rights reserved.7–17 Miscellaneous recent research findings... Non-acquirers are more likely to outperform the market than active acquirers Some large proficient acquirers do many successful deals; more typically, companies do few but very unsuccessful deals Best success potential is with small- or mid- sized deals that fill gaps in related product lines or aid in globalization

Copyright © 2004 South-Western. All rights reserved.7–18 Miscellaneous recent research findings... Business redefinition via acquisition or merger is generally unsuccessful Larger CEO egos are associated with larger acquisition premiums! In general, firms are getting better at acquisitions, but most still destroy shareholder wealth

Copyright © 2004 South-Western. All rights reserved.7–19 Acquisitions Reasons for Acquisitions and Problems in Achieving Success Adapted from Figure 7.1 Integration difficulties Inadequate evaluation of target Large or extraordinary debt Inability to achieve synergy Too much diversification Managers overly focused on acquisitions Too large

Copyright © 2004 South-Western. All rights reserved.7–20 Problems in Achieving Acquisition Success: Integration Difficulties Integration challenges include: ...

Copyright © 2004 South-Western. All rights reserved.7–21 Problems in Achieving Acquisition Success: Inadequate Evaluation of the Target What information should you “evaluate” about the firm targeted for acquisition?  ?

Copyright © 2004 South-Western. All rights reserved.7–22 Problems in Achieving Acquisition Success: Inadequate Evaluation of the Target Due Diligence = the process of evaluating a target firm for acquisition  Ineffective due diligence may result in paying an excessive premium for the target company

Copyright © 2004 South-Western. All rights reserved.7–23 Problems in Achieving Acquisition Success: Large or Extraordinary Debt Problematic effects of high debt = ?? ?? ?? ?? ?? ??

Copyright © 2004 South-Western. All rights reserved.7–24 Problems in Achieving Acquisition Success: Inability to Achieve Synergy Synergy exists when assets are worth more when used in conjunction with each other than when they are used separately  Firms tend to underestimate indirect costs and overestimate value of synergies - the “rose-colored glasses” style of forecasting”!  Strategy implementation is often more difficult than strategy formulation!  Examples =

Copyright © 2004 South-Western. All rights reserved.7–25 Problems in Achieving Acquisition Success: Too Much Diversification Diversified firms often move outside their areas of competence Diversified firms must process more information of greater diversity - what can HQ executives comprehend/understand? Diversification may cause managers to rely too much on financial rather than strategic controls to evaluate division performance Are acquisitions a “crutch” for poor innovation?

Copyright © 2004 South-Western. All rights reserved.7–26 Two Basic Types of Organizational Controls Financial ControlsStrategic Controls

Copyright © 2004 South-Western. All rights reserved.7–27 Problems in Achieving Acquisition Success: Too Large Additional costs of controls may exceed benefits of the economies of scale and additional market power Larger size may lead to more bureaucratic controls, more standardization, and more rigid managerial behavior = NO FUN! LESS FLEXIBILITY! REDUCED INNOVATION!

Copyright © 2004 South-Western. All rights reserved.7–28 Problems in Achieving Acquisition Success: Managers Overly Focused on Acquisitions Managers in target firms suspend initiatives Managers in acquirers invest substantial time and energy in acquisition strategies:  Searching for/courting acquisition candidates  Conducting due-diligence processes  Managing post-acquisition integration process “The urge to merge”; “addiction”; “fun”... excitement, power, prestige, intrigue...

Copyright © 2004 South-Western. All rights reserved.7–29 Attributes of Successful Acquisitions Complementary assets; relatedness in strategically important ways Use of “pre-selection criteria” Friendly acquisition Careful negotiation Financial slack; moderate debt Continuing innovation in acquiring firm Firms are adaptable to change Conscientious people management

Copyright © 2004 South-Western. All rights reserved.7–30 “3 Tests” for Successful Diversification, suggested by Michael Porter 1. The Attractiveness Test - Is the INDUSTRY attractive? 2. The Cost-of-Entry Test - Is the cost of the acquisition reasonable, given predicted returns over time? 3. The Better-Off Test - Can meaningful synergies be captured? (Activity sharing? Skill transfer?)

Copyright © 2004 South-Western. All rights reserved.7–31 More corporate strategy advice from Michael Porter... First, fully develop the core business Then, use the “3 tests” to move beyond core business, with careful negotiation Avoid unrelated businesses - COMPETENCE IS NECESSARY! Seek realistic sources of synergy that impact competitive advantage Practice timely “outplacement” of divisions Pay shareholder dividends!

Copyright © 2004 South-Western. All rights reserved.7–32 Restructuring A strategy through which a firm changes its set of businesses or financial structure  Failure of an acquisition strategy often precedes a restructuring strategy  Restructuring may occur because of changes in the external or internal environments 3 main restructuring approaches:

Copyright © 2004 South-Western. All rights reserved.7–33 Restructuring Downsizing searching the value chain for efficiencies reducing the workforce outcomes are often disappointing - WHY? Downscoping eliminating an entire business unit, or “divestiture” can sell off, spin off, or liquidate facilitate refocusing on core competencies helps reduce debt generally produces better results than downsizing

Copyright © 2004 South-Western. All rights reserved.7–34 LBOs =... the assets of the firm are purchased, largely financed by debt, and the firm is taken private Advantages?Disadvantages?

Copyright © 2004 South-Western. All rights reserved.7–35 Restructuring and Outcomes Adapted from Figure 7.2

Copyright © 2004 South-Western. All rights reserved.7–36 Current Trends in Corporate-Level Strategy Less diversification; more downscoping Increased reliance on core competencies: - more single/dominant businesses; - more related diversifiers, working with activity sharing and skill transfer Strategic alliance is often used instead of vertical integration Internationalization reduces the need for broad diversification