Strategic Management/
Business Policy
Power Point Set #8
EMBA 544
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 multimarket 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.
Summary: Creating Value in Vertical
Activities
Be Better Than Competitors
(1)
In determining whether activities should be internal or external:
External
Supplier
(2)
Internal Activities
External
Customer
In coordinating these activities along the value chain:
Vertical Scope of the Firm 20
Voigt, Fall, 1998
Vertical Integration
Why vertically integrate?
Market Power
entry barriers
down stream price maintenance
up stream power over price
Efficiency
specialized assets & the holdup problem
protecting product quality
improved scheduling
Transactions
Transactions Costs
Costs and
and the
the
Scope
Scope of
of the
the Firm
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
SPECIALIZED V2
FIRMS
V3
P1
P2
P3
A1 A2
A3
Common Issue--- What are TRANSACTION COSTS of markets
compared with administrative costs of the firm?
Vertical Integration
Professor 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)?
Optimal Input Procurement
No
Substantial
specialized
investments
relative to
contracting costs?
Yes
No
Contract
Managerial Eco. - Rutgers University
Spot Exchange
Complex contracting
environment relative to
costs of integration?
Yes
Vertical
Integration
6-13
Types of strategic alliance
Strategic alliances
Non-equity alliance
Cooperation between firms
is managed directly through
contracts without crossequity holding or an
independent firm being
created
Joint Venture
Cooperating firms form an
independent firm in which
they invest. Profits from this
independent firm compensate
partners for this investment
Equity alliance
Cooperative contracts are
supplemented by equity
investments by one partner in the
other partner. Sometimes these
investments are reciprocated
Formal
Formal
Networks
Networks
Network-Based
Network-Based
Organizations
Organizations
Informal
Informal
Networks
Networks
Expediting
Expediting Multidisciplinary
Multidisciplinary
Communication
Communication
Electronic
Electronic
Networks
Networks
Structuring the Alliance to Reduce
Opportunism
Walling off
critical technology
Establishing
contractual
safeguards
Opportunism by partner
reduced by:
Figure 14.1
© McGraw Hill Companies, Inc., 2000
Agreeing to swap
valuable skills
and technologies
Seeking credible
commitments
14-21
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”:
Sales Growth maximization as emphasized
by Professor William Baumol of Princeton
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
The Industry Attractiveness-Business
Strength Matrix
Industry Attractiveness
Business Strength
High
© 1999 Pankaj Ghemawat
Medium
Low
High
Investment
and
Growth
Medium
Selective
Growth
Selectivity
Harvest/
Divest
Selectivity
Harvest/
Harvest/
Divest
Divest
Harvest/
Harvest/
Divest
Divest
Low
Selective
Growth
Selectivity
Mergers and Acquisitions
A merger is a strategy through
which two firms agree to integrate
their operations on a relatively coequal 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.
Problems in
Achieving Success
Reasons for
Acquisitions
Increased
market power
Integration
difficulties
Overcome
entry barriers
Inadequate
evaluation of target
Cost of new
product development
Large or
extraordinary debt
Increased speed
to market
Acquisitions
Inability to
achieve synergy
Lower risk
compared to developing
new products
Too much
diversification
Increased
diversification
Managers overly
focused on acquisitions
Avoid excessive
competition
Too large
Ch7-3
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
Mergers and Acquisitions
Value Created
Deal
Value Destroyed
Year Since Combination Since Combination
AOL/Time Warner
2001
Vodafone/Mannesmann 2000
Pfizer/Warner-Lambert 2000
Glaxo/SmithKline
2000
Chase/J. P. Morgan
2000
Exxon/Mobil
1999
SBC/Ameritech
1999
WorldCom/MCI
1998
Travelers/Citicorp
1998
Daimler/Chrysler
1991
_____
_____
_____
_____
_____
$ 8 billion
_____
_____
$109 billion
_____
$148 billion
$299 billion
$78 billion
$40 billion
$26 billion
_____
$68 billion
$94 billion
_____
$36 billion
As of July 1, 2002.
Source: K. H. Hammonds, “The Numbers Don’t Lie,” Fast Company, September 2002, p. 80.
Exhibit 6.5 Ten Biggest Mergers and Acquisitions of All Time and Their Effect on Shareholder Wealth
Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved.
6-31
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 overestimates 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?
(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
