Chapter 6: Corporate Level Strategy: Creating Value through Diversification

By estimates, 70 to ________% of acquisitions destroy shareholder value

90%

Divestment can be the common result of an acquisition. Divesting businesses can accomplish many different objectives. These include:

A) enabling managers to focus their efforts more directly on the firm's core businesses. B) providing the firm with more resources to spend on more attractive alternatives. C) raising cash to help fund existing businesses. D) all of the above. ANSWER: D

Strategic Alliance/Joint Venture

A cooperative relationship between two or more firms. Joint ventures = new entities formed within a strategic alliance in which two or more firms, the parents, contribute equity to form the new legal entity. Finally, corporations may diversify into new products, markets, and technologies through internal development. Strategic alliances and joint ventures are assuming an increasingly prominent role in the strategy of leading firms, both large and small. A strategic alliance can help firms better understand customer needs, acquire know-how for promoting the product, acquire access to the proper distribution channels Strategic alliances may also be used to build jointly on the technological expertise of two or more companies, enabling them to develop products beyond the capability of other companies acting independently. POTENTIAL ADVANTAGES: Ability to enter new markets through. - Greater financial resources. - Greater marketing expertise. - Ability to reduce manufacturing or other costs in the value chain. - Ability to develop & diffuse new technologies. LIMITATIONS: Despite their promise, many alliances and joint ventures fail to meet expectations for a variety of reasons. The proper partner is essential. The need for the proper partner: - Partners should have complementary strengths - Partner's strengths should be unique - Uniqueness should create synergies - Synergies should be easily sustained & defended - Partners must be compatible & willing to trust each other

Core Competencies

A firm's strategic resources that reflect the collective learning in the organization. This collective learning includes how to coordinate diverse production skills, integrate multiple streams of technologies, and market diverse products and services. Core competencies = the glue that binds existing businesses together, achieved by transferring accumulated skills and expertise across business units in a corporation. Core competencies can lead to the creation of value and synergy , but these core competencies must enhance competitive advantage(s) by creating superior customer value - by building on existing skills and innovations in a way that appeals to customers, as at Apple. The value chain elements in separate businesses require similar skills. Finally, core competencies must be difficult for competitors to imitate or find substitutes for.

Portfolio Management

A method of (a) assessing the competitive position of a portfolio of businesses within a corporation, (b) suggesting strategic alternatives for each business, and (c) identifying priorities for the allocation of resources across the businesses. The KEY PURPOSE of portfolio models is to assist a firm in achieving a balanced portfolio of businesses. A balanced portfolio consists of businesses whose profitability, growth, and cash flow characteristics complement each other and add up to a satisfactory overall corporate performance. Portfolio analysis allows the corporation to: (1) to allocate resources among the business units according to prescribed criteria (i.e. use cash flows from the "cash cows" to fund promising "stars"); (2) identify attractive acquisitions; (3) provide financial resources on favorable terms; (4) provide high-quality review and coaching for the individual businesses; (5) provide a basis for developing strategic goals and rewards/evaluation systems for business managers.

Corporate Level Strategy

A strategy that focuses on gaining long-term revenue, profits, and market value through managing operations in multiple businesses. Determining how to create value through entering new markets, introducing new products, or developing new technologies is a vital issue in strategic management, but maintaining a focus on "creating value" is essential to long-term success.

Shaw Industries, a giant carpet manufacturer, increases its control over raw materials by producing much of its own polypropylene fiber, a key input into its manufacturing process. This is an example of:

A) leveraging core competencies. B) pooled negotiating power. C) vertical integration. D) sharing activities. ANSWER: C

Sharing core competencies is one of the primary potential advantages of diversification. In order for diversification to be most successful, it is important that.....

A) the similarity required for sharing core competencies must be in the value chain, not in the product. B) the products use similar distribution channels. C) the target market is the same, even if the products are very different. D) the methods of production are the same. ANSWER: A

Vertical Integration

Am expansion or extension of the firm by integrating preceding or successive production processes. Vertical integration occurs when a firm becomes its own supplier or distributor. Vertical integration occurs when a firm becomes its own supplier or distributor. The firm can incorporate more processes toward the original source of raw materials (BACKWARD integration) or toward the ultimate consumer (FORWARD integration). In making vertical integration decisions, FIVE issues should be considered: 1) Is the company satisfied with the quality of the value that its present suppliers & distributors are providing? 2) Are there activities in the industry value chain presently being outsourced or performed independently by others that are a viable source of future profits? 3) Is there a high level of stability in the demand for the organization's products? 4) Does the company have the necessary competencies to execute the vertical integration strategies? 5) Will the vertical integration initiatives have potential negative impacts on the firm's stakeholders?

Antitakeover Tactics

Antitakeover tactics include: 1) GREEN MAIL: A payment by a firm to a hostile party for the firm's stock at a premium, made when the firm's management feels that the hostile party is about to make a tender offer. 2) GOLDEN PARACHUTES: A prearranged contract with managers specifying that, in the event of a hostile takeover, the target firm's managers will be paid a significant severance package. 3) POISON PILLS: Used by a company to give shareholders certain rights in the event of takeover by another firm. ^Can benefit multiple stakeholders - not just management. Can raise ethical considerations because the managers of the firm are not acting in the best interests of the shareholders.

Related Businesses/Diversification

Are those that share resources. RELATED DIVERSIFICATION: A firm entering a different business in which it can benefit from leveraging core competencies, sharing activities, or building market power. *Benefits derive from horizontal relationships: - Sharing intangible resources such as core competencies in marketing. - Sharing tangible resources such as production facilities, distribution channels via vertical integration. **Related businesses gain market power by: Pooled negotiating power Vertical integration

Divestments, the exit of the business from the firm's portfolio, are quite _____________.

Common

Economies of Scope

Cost savings from leveraging core competencies or sharing related activities among businesses in a corporation. Economies of scope allow businesses to: - Leverage core competencies - Sharing related activities - Enjoy greater revenues, enhance differentiation.

Successfully executing strategies of vertical integration can be very _______________ and can require significant competencies.

Difficult **Managers must carefully consider the impact that vertical integration may have on existing and future customers, suppliers, and competitors.

Internal Development

Entering a new business through investment in new facilities, often called corporate entrepreneurship and new venture development. Compared to mergers and acquisitions, firms that engage in internal development capture the value created by their own innovative activities without having to share the wealth with alliance partners or face the difficulties associated with combining activities across the value chains of several firms or merging corporate cultures. On their own, firms can often develop new products or services that are relatively lower cost, and thus rely on their own resources rather than turning to external funding. However this may be time-consuming, so firms may forfeit the benefits of speed that growth through mergers or acquisitions can provide. In addition, firms that choose to diversify through internal development must develop capabilities that allow them to move quickly from initial opportunity recognition to market introduction. CORPORATE ENTREPRENEURSHP & new venture development motives: - No need to share the wealth with alliance partners - No need to face difficulties associated with combining activities across the value chains - No need to merge diverse corporate cultures LIMITATIONS: Time-consuming Need to continually develop new capabilities

Transaction Cost Perspectiver

Every market transaction involves some transaction costs: Search costs Negotiating costs Contract costs Monitoring costs Enforcement costs Need for transaction specific investments Administrative costs Transaction costs are the sum of the above costs. These transaction costs can be avoided by internalizing the activity, in other words, by producing the input in-house. However, vertical integration gives rise to administrative costs as well. Coordinating different stages of the value chain now internalized within the firm causes administrative costs to go up. Decisions about vertical integration are, therefore, based on a comparison of transaction costs and administrative costs. If transaction costs are lower than administrative costs, it is best to resort to market transactions and avoid vertical integration. On the other hand, if transaction costs are higher than administrative costs, vertical integration becomes an attractive strategy.

Market Power

Firms' abilities to profit through restricting or controlling supply to a market or coordinating with other firms to reduce investment.

Unrelated Businesses/Diversification

Have few similarities in products or industries, however the corporate office can add value through such activities as robust information systems or superb human resource practices. UNRELATED DIVERSIFICATION: A firm entering a different business that has little horizontal interaction with other businesses of a firm. Benefits of unrelated diversification come from the vertical or hierarchical relationships, or creation of synergies from the interaction of the corporate office with the individual business units. The corporate office can contribute to parenting and restructuring of often acquired businesses or can add value by viewing the entire corporation as a family or portfolio of businesses and allocating resources to optimize corporate goals of profitability, cash flow, and growth. **Benefits derive from hierarchical relationships: - Value creation derived from the corporate office. - Leveraging support activities in the value chain.

Sharing Activities

Having activities of two or more businesses' value chains done by one of the businesses. A firm can also enjoy greater revenues if two businesses attain higher levels of sales growth combined than either company could attain independently (this is the synergistic effect). Firms also can enhance the effectiveness of their differentiation strategies by means of sharing activities among business units. A shared order-processing system, for example, may permit new features and services that a buyer will value. Sharing tangible & value-creating activities can provide payoffs: 1) Cost savings through elimination of jobs, facilities & related expenses, or economies of scale. 2) Revenue enhancements through increased differentiation & sales growth. COST SAVINGS are generally highest when one company acquires another from the same industry in the same country. Sharing activities inevitably involve costs that the benefits must outweigh such as the greater coordination required to manage a shared activity. Sharing activities can also increase the EFFECTIVENESS of differentiation strategies. For instance, a shared order-processing system may permit new features and services that a buyer will value. However, sharing activities among businesses in a corporation can have a negative effect on a given business's differentiation. An example is when Ford owned Jaguar and customers found out it shared its basic design and manufacturing with the Mondeo; customers had a lower perceived value of Jaguar.

Unfriendly or ___________ takeovers can occur when a company's stock becomes undervalued.

Hostile

Corporate Entrepreneurship

Involves the leveraging and combining of the firm's own resources and competencies to create synergies and enhance shareholder value.

Limitations of Portfolio Models

Limitations of portfolio models: comparing SBUs on only two dimensions, viewing each SBU as a stand-alone entity and ignoring synergies, treating the process as largely mechanical, relying on strict rules for resource allocation, making overly simplistic prescriptions and ignoring a firm's potential long-term viability.

Managerial Motives

Managers acting in their own self interest rather than to maximize long-term shareholder value. This can lead to eroding versus enhancing value creation through: 1) GROWTH FOR GROWTH's SAKE: managers' actions to grow the size of their firms not to increase long-term profitability but to serve managerial self-interest. There is a "tremendous allure to mergers and acquisitions," which can lead to desperate moves by top managers to satisfy investor demands for accelerating revenues, sometimes by engaging in unethical behavior. 2) EGOTISM: managers' actions to shape their firms' strategies to serve their selfish interests rather than to maximize long-term shareholder value. Egos can get in the way of a synergistic corporate marriage. 3) Use of ANTITAKEOVER TACTICS: managers' actions to avoid losing wealth or power as a result of a hostile takeover.

Benefits derived from horizontal (related diversification) and hierarchical (unrelated diversification) relationships are not ____________ _______________ .

Mutually Exclusive

BCG Matrix

Relative market share is measured by the ratio of the business units size to that of its largest competitor. Growth rate is estimated from market data. The FOUR quadrants of the grid include STARS: firms with long-term growth potential that should continue to receive substantial investment funding; QUESTION MARKS: SBUs operating in high-growth industries with relatively weak market shares where resources should be invested in them to enhance their competitive positions;CASH COWS: SBUs with high market shares in low-growth industries that have limited long-run potential but represent a source of current cash flows to fund investments in "stars" and "question marks"; DOGS: SBUs with weak positions and limited potential - most analysts recommend that they be divested.

Merger

The combining of two or more firms into one new legal entity. In certain industries speed is critical, so acquiring is faster than building. Example = Apple acquiring Siri Inc. Acquisitions can quickly add new technology to product offerings and meet changing customer needs. Example = Cisco Systems. Acquisitions can help a firm leverage core competencies, share activities, and build market power. Example = eBay's acquisition of GSI Commerce, StubHub and Gmarket allows it to become a full-service provider of online retailing systems. M&A can lead to consolidation within an industry, forcing other players to merge: ie; consolidation in the airline industry: Delta - Northwest, United - Continental. Corporations can also enter a new market segments by way of acquisitions. ie; Fiat acquired Chrysler to gain access to the U.S. auto market.

Divestment

The exit of a business from the firm's portfolio. By using a joint venture or strategic alliance, corporations can pool the resources of other companies with their own resource base. Divestment objectives include: 1) Cutting the financial losses of a failed acquisition 2) Redirecting focus on the firm's core businesses 3) Freeing up resources to spend on more attractive alternatives 4) Raising cash to help fund existing businesses Successful divestment requires a thorough understanding of a business unit's current ability and future potential to contribute to a firm's value creation. Since the decision to divest involves a great deal of uncertainty, it's very difficult to make such evaluations. In addition, because of managerial self interests and organizational inertia, firms often delay investments of underperforming businesses. The Boston Consulting Group has identified the following seven principles for successful divestiture: 1)Removing emotion from the decision 2) Knowing the value of the business you're selling 3) Timing the deal right 4) Maintaining a sizable pool of potential buyers 5) Telling a story about the deal 6) Running divestitures systematically through a project office 7)Communicating clearly and frequently

Pooled Negotiation Power

The improvement in bargaining position relative to suppliers and customers. Be careful, though: acquiring related businesses can enhance a corporation's bargaining power, but it must be aware of the potential for retaliation.

Acquisition

The incorporation of one firm into another through purchase. Through mergers and acquisitions, corporations can directly acquire another firm's assets and competencies. A firm can also divest previous acquisitions.

Restructuring

The intervention of the corporate office in a new business that substantially changes the assets, capital structure, and/or management, including selling off parts of the business, changing the management, reducing payroll and unnecessary sources of expenses, changing strategies, and infusing the new business with new technologies, processes, and reward systems.

Parenting Advantage

The positive contributions of the corporate office to a new business as a result of expertise and support provided, and not as a result of substantial changes in assets, capital structure, or management. Parenting relates to the positive contributions of the corporate office to a new business as a result of expertise and support provided in areas such as legal, financial, human resource management, procurement, and the like. Corporate parents also help subsidiaries make wise choices in their own acquisitions, divestitures, and new internal development decisions. The parent intervenes, often selling off parts of the business; changing the management; reducing payroll and unnecessary sources of expenses; changing strategies; and infusing the company with new technologies, processes, reward systems, and so forth. When the restructuring is complete, the firm can either "sell high" and capture the added value or keep the business and enjoy financial and competitive benefits. In order for this to work, the corporate parent must have the requisite skills and resources to turn the businesses around, even if they may be in new and unfamiliar industries.

Diversification

The process of firms expanding their operations by entering new businesses. Diversification initiatives - whether through mergers and acquisitions, strategic alliances and joint ventures, or internal development - must be justified by the creation of value for shareholders. Many firms that diversify into related areas benefit from information technology expertise in the corporate office. Similarly, unrelated diversifiers often benefit from the "best practices" of sister businesses even though their products, markets, and technologies may differ dramatically. An example would be a corporate parent with strong support activities in the value chain such as information systems or human resource practices.