Strategic Management/ Business Policy Joe Mahoney

Corporate 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 Strategy Vertical Integration Strategic Alliances Diversification (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 Integration Defining 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.

Vertical Integration Why vertically integrate? Market Power Efficiency entry barriers down stream price maintenance up stream power over price Efficiency specialized assets & the holdup problem protecting product quality improved scheduling

Vertical 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)?

Diversification Diversification Issues 1. Motives for diversification 2. Mode of diversification 3. Measurement of diversification

Motivations 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 development Utilizing excess capacity (e.g., in distribution)

Motivations For Diversification Value Enhancing Motives: Developing New Competencies (Stretching) Efficient Management Financial Motives internal capital allocation & restructuring risk reduction tax advantages Increase market power multi-point competition

Other Motivations For Diversification: Motivations that “Devaluate”: Growth maximization managerial capitalism/agency problem protect against “unemployment risk” maximize management compensation Motivations that are “Value neutral”: Diversification motivated by poor performance in current businesses.

Diversification 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.

Diversification 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.

Diversification 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.

Diversification 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 diversification Choice of mode of diversification: Internal development Acquisition Joint venture Licensing

Mergers and Acquisitions Increasing use of mergers & acquisitions 1980s: 55,000 M&As: total value $1.3 trillion 1998: total value $2.5 trillion 1999: total value $3.4 trillion IN UNITED STATES: 1998: total value $1.6 trillion 1999: total value $1.75 trillion

Mergers and Acquisitions 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.

Mergers and Acquisitions 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.

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

Mergers and Acquisitions Reasons for Acquisitions Increased 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

Mergers and Acquisitions 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 Acquisitions Problems 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 Acquisitions Problems 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

Sustainable 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.

Sustainable Competitive Advantage 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.

Sustainable Competitive Advantage 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 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 -- LBOs Purchase involving mostly borrowed funds Generally occurs in mature industries where R&D is not central to value creation High debt load commits cash flows to repay debt, creating discipline for managers Increases concentration of ownership Focuses attention of management on shareholder value