Strategic Management/ Business Policy

Power Point Set #6:Corporate Strategy

Corporate Level Strategy

Corporate-level strategy concerns the selection and management of a mix of businesses competing in several industries or product markets.

It is the way a company creates value through the configuration and coordination of multi-market activities:

To add economic 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.

Understanding the Value Chain

Raw Materials

Manufacturing

Distribution

Backward Integration

Forward Integration

Diversification

Vertical IntegrationVertical IntegrationProfessor Oliver Williamson of University of California at Berkeley has made clear that 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)?

Vertical Integration

Why vertically integrate?

Market Power (increase revenue)Entry barriersDown-stream price maintenanceUp-stream power over price

Efficiency (lower cost)Specialized assets & the holdup problemProtecting product qualityImproved scheduling

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

Risks in undertaking cooperative agreements or strategic alliances

Adverse selection Partners misrepresent skills, ability and other

resources

Moral Hazard Partners provide lower quality skills and

abilities than they had promised

Holdup Partners exploit the transaction specific

investment made by others in the alliance

Motivations For Diversification

Value Enhancing Motives:

Increase market power• Multi-point competition

R&D and new product developmentDeveloping New Competencies (Stretching)Transferring Core Competencies (Leveraging)

• Utilizing excess capacity (e.g., in distribution)• Economies of Scope • Leveraging Brand-Name (e.g., Haagen-Dazs to

chocolate candy)

Other Motivations For Diversification

Motivations that are “Value neutral”:

Diversification motivated by poor economic performance in current businesses.

Motivations that “Devaluate”:

Agency problemManagerial capitalism (“empire building”)Maximize management compensationSales Growth maximization • Professor William Baumol

DiversificationIssue #1: 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 economic incentive to diversify to a point that is detrimental to stockholders.

DiversificationIssue #2: There may be no economic value to stockholders in diversification moves since stockholders are free to diversify by holding a portfolio of stocks. 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 economic value.

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

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

Mergers and AcquisitionsA 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

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

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:

• Quaker Oats, in late 1994, purchased Snapple Beverage Company for $1.7 billion. Many analysts calculated that Quaker Oats paid about $1 billion too much for Snapple. In 1997, Quaker Oats sold Snapple for $300 million.

Sustainable Competitive Advantage

Under what scenarios can the bidder do well?

Luck

Asymmetric Information– This eliminates the competitive bidding premise

implicit in the “efficient market hypothesis”

Specific-synergies between the bidder and the target.

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