MGT 499- Chapter 8

horizontal mergers can be attractive for several reasons

-Aimed at lowering costs by achieving greater economies of scale -Provide access to new distribution channels

Examples of mergers and acquisitions in horizontal integration

-ExxonMobil is a direct rescendant of John D. Rockefellers standard oil company. It was formed by the 1999 merger of Exxon and Mobil. As in many mergers, the new company name combines the old company names. -starbucks acquired competitor seattles best coffee-- which had a presence in Borders Bookstores and Subway Restaurants-- in order to target a more working class audience without diluting the starbucks brand -Bill Hewlett and Dave Packard formed Hewlett-Packard in a garage after graduating from Standford in 1935. In recent years, HP has pursued horizontal integration through a merger with Compaq and the acquisition of Palm

Despite the potential benefits of mergers and acquisitions, their financial results often are very disappointing

-More than 60 percent of mergers and acquisitions erode shareholder wealth -Fewer than one in six increases shareholder wealth. One study found that more than 60 percent of mergers and acquisitions erode shareholder wealth while fewer than one in six increases shareholder wealth. Thus executives need to be cautious when considering using horizontal integration.

leveraged buyouts (LBOs)

-One party buys all of a firm's assets in order to take the firm private (or no longer trade the firm's shares publicly) -Private equity firm: Firm that facilitates or engages in taking a public firm private -Three types of LBOs ----Management buyouts, Employee buyouts, Whole-firm buyouts Why?

takeover

-Special type of acquisition strategy wherein the target firm did not solicit the acquiring firm's bid -Hostile Takeover: Unfriendly takeover that is unexpected and undesired by the target firm

reasons for acquisitions in vertical integration

-increased market power -overcoming entry barriers -cost of new product development and increased speed to market -lower risk compared to developing new products -increased diversification -reshaping the firms competitive scope -learning and developing new capabilities

Problems in achieving success in vertical integration

-integration difficulties -inadequate evaluation of target -large or extraordinary debt -inability to achieve synergy -too much diversification -managers overly focused on acquisitions -too large Vertical integration also creates risk. Venturing into new portions of the value chain can take a firm into very different businesses.

Dominant Business

...

single business

95% or more of the revenue comes from a single business

key take away

A concentration strategy involves trying to compete successfully within a single industry. Market penetration, market development, and product development are three methods to grow within an industry. Mergers and acquisitions are popular moves for executing a concentration strategy, but executives need to be cautious about horizontal integration because the results are often poor.

Portfolio planning

A process that helps executives make decisions involving their firms' various industries -Offers suggestions about what to do within each industry, and provides ideas for how to allocate resources across industries. -It first gained widespread attention in the 1970s and it remains a popular tool among executives today --Can be useful for analyzing firms that participate in a wide variety of industries

forward vertical integration

A strategy that involves a firm entering a buyer's business (strategy involves a firm moving further down the value chain to enter a buyers business). Useful for neutralizing the effect of powerful buyers (American apparal uses forward integration by entering a buyers business--by operating 250 plus company-owned store worldwide) _disney uses this by operating more than three hundred retail stores that sell merchandise based on disneys character and movies. This allows disney to capture profits that would otherwise be enjoyed by another source.

backward vertical integration

A strategy that involves a firm moving back along the value chain and entering a suppliers business. (A strategy that involves a firm entering a supplier's business). Some firms use this strategy when executives are concerned that a supplier has too much power over their firms. Used when executives are concerned that a supplier has too much power over their firms (ex at American Apparel: entering a suppliers business-- is evident as all clothing design is done in house-often using employees as models)

concentration strategies

Actions that firms use to try to compete successfully only within a single industry strategies that firms use to try to successfully compete only within a single industry. 3 types: -market penetration -market development -product development

restructuring strategies

Alternatives: -downsizing, downscoping, and leveraged buyout lead to... short term outcomes: -reduced labor costs, reduced debt costs, emphasis on strategic controls, high debt costs lead to... long-term outcomes: -loss of human capital, lower performance, higher performance, higher risk

market penetration

An attempt to gain additional share of existing markets using existing products. ex: involves trying to gain additional share of a firms existing markets using existing products--often by relying on extensive advertising. perhaps the most famous example of two close rivals simultaneously attempting market penetration is the cola wars where coke and pepsi fight for share in the soft drink market. perpsis blind taste tests in 1975 called the pepsi challenge is one of the more famous attacks in this ongoing battle

...

Best-known approach to portfolio planning -Using the matrix requires a firm's businesses to be categorized as high or low along two dimensions: ------Its share of the market ------The growth rate of its industry

key take away

Diversification strategies involve firmly stepping beyond its existing industries and entering a new value chain. Generally, related diversification (entering a new industry that has important similarities with a firm's existing industries) is wiser than unrelated diversification (entering a new industry that lacks such similarities).

downscoping

Eliminating businesses unrelated to firms' core businesses through divesture, spin-off, or some other means

Key take away

Executives sometimes need to reduce the size of their firms to maximize the chances of success. This can involve fairly modest steps such as retrenchment or more profound restructuring strategies.

restructuring

Firm changes set of businesses or financial structure. ex: spin-offs occur when businesses create a new firm from a piece of their operations. Because some diversified firms are too complex for investors to understand, breaking them up can create wealth by resulting in greater stock market valuations. Spinning off a company also reduces management layers, which can lower costs and speed up decisions making. Below we describe a variety of firms that were created as spin-offs: --there are 17 billion of Freescale Semiconductors chips in use around the world. the firm was spun-off from Motorola in 2004. --Toyota started in the car business, right? Wrong. The firm was spun-off in the 1930s from Toyoda Automatic Loom Works- a company that produced commercial weaving looms --the 2000 merger between America Online (AOL) and Time Warner was one of the largest in history. The firms split in 2009ll. Net result? a staggering 99 billion dollar loss. --Delphi Automotive--an automotive parts company headquartered in Michigan- is a spin off from General Motors --Guidant Corporation-a spin off from Eli Lilly- designs and manufactures artificial pacemakers, defibrillators, stents, and other heart-helpful medical products.

Another approach to portfolio planning: Attractiveness strength matrix

Ge developed this to examine its diverse activities. This planning approach involves rating each of a firm's businesses in terms of the attractiveness of the industry and the firm's strength within the industry. Each dimension is divided into three categories, resulting in nine boxes

Stars

High market share units within fast-growing industries. These units have bright prospects and thus are good candidates for growth.

cash cows

High market share units within slow-growing industries. Because their industries have bleak prospects, profits from cash cows should not be invested back into cash cows but rather diverted to more promising businesses.

Value-neutral diversification: incentives and resources

Incentives to diversify: -antitrust regulations and tax laws -low performance -uncertain future cash flows -synergy and firm risk reduction -resources and diversification

Levels and types of diversification

Low levels of diversification -single business and dominant business moderate to high levels of diversification -related constrained and related linked (mixed related and unrelated) Very high levels of diversification -unrelated

dogs

Low market share units within slow-growing industries. These units are good candidates for divestment.

limitations to portfolio planning

Oversimplifies the reality of competition by focusing on just two dimensions when analyzing a company's operations within an industry Can create motivational problems among employees Does not help identify new opportunities

key take away

Portfolio planning is a useful tool for analyzing a firm's operations, but this tool has limitations. The BCG matrix is one of the most widely used approaches to portfolio planning.

Retrenchment/downsizing

Reducing the size of part of a firm's operations, often through laying off employees -Firms following a retrenchment strategy shrink one or more of their business units -Firms using this strategy hope to make just a small retreat rather than losing a battle for survival

Merger

The joining of two similarly sized companies into one company. so... two firms agree to integrate their operations on a relatively co-equal basis

Diversification discount

The tendency of investors to undervalue the shares of a diversified firm. Investors often struggle to understand the complexity of diversified firms, and this can result in relatively poor performance by the stocks of such firms

Key take away

Vertical integration occurs when a firm gets involved in new portions of the value chain. By entering the domain of a supplier (backward vertical integration) or a buyer (forward vertical integration), executives can reduce or eliminate the leverage that the supplier or buyer has over the firm.

reasons for diversification

a number of reasons exist including: -value creating---operational relatedness and corporate relatedness -value-neutral -value-reducing

vertical integration strategies

backwards and forwards

low industry growth rate and low relative market share

cash cows should be "milked" to supply funds to more promising businesses

portfolio planning and corporate level strategy

compared to industry growth rate and relative market share -stars -question marks -cash cows -dogs

Diversification Strategies

involve a firm entering entirely new industries. Requires moving into new value chains. Three tests for diversification: -how attractive is the industry that a firm is considering entering (benefits?) -how much will it cost to enter the industry? (costs?) -will the new unit and the firm be better off (synergy?)

product development

involves creating new products to serve exisitng markets. ex: King Gillette an american businessman whose family hailed from france, pioneered the safety razon that bears his family name. his companys more recent innovations in the razor market including trac 11 (the first two bladed razor), atra (first razor with a pivoting head), sensor (first razor with spring loaded blades), Mach 3 (first three blade razor), and fusion (first six-blade razor) is the ten blade razor coming soon?

market development

involves taking existing products and trying to sell them within new markets. ex: starbucks engages in market development by selling their beans and bottled drinks in grovery stores. Apple engages in market development by allowing customers in starbucks stores to connect directly to itunes store and starbucks now playing content. customers are offered a free download to get them to visit itunes-and to perhaps purchase more songs

Boston Consulting Group (BDG) Matrix

is the best-known approach to portfolio planning. Using the matrix requires a firm's businesses to be categorized as high or low along two dimensions: its share of the market and the growth rate of its industry. separated into --cash cows --dogs --stars --question marks

low industry growth rate and high relative market share

it should mean, but does should be sold if possible and abandoned if necessary

related linked (mixed related and unrelated)

less than 70% of revenue comes from the dominant business, and there are only limited links between businesses

question marks

low-market-share units within fast-growing industries. Executives must decide whether to build these units into stars or to divest them.

unrelated diversification

occurs when a firm enters an industry that lacks any important similarities with the firm's existing industry or industries. less than 70% of revenue comes from the dominant business, and there are no common links between businesses Most do not have happy endings.. ex: Harley-Davidson, for example, once tried to sell Harley-branded bottled water. Starbucks tried to diversify into offering Starbucks-branded furniture. Both efforts were disasters.

Related constrained

occurs when a firm moves into a new industry that has important similarities with the firm's existing industry or industries less than 70% of revenue comes from the dominant business and all businesses share product, technological, and distribution linkages Firms that engage in related diversification aim to develop and exploit a core competency (Which is a skill set that is difficult for competitors to imitate, can be leveraged in different businesses, and contributes to the benefits enjoyed by customers within each business) to become more successful. (companies leveraging its new ability within its new business)

Horizontal integration

pursing a concentration strategy by acquiring or merging with a rival. it can also provide access to new distribution channels. types: -acquisition -mergers -takeover

high industry growth rate and high relative market share

question marks should be resolved by executives by deciding whether to foster or sell these units or not

Divestment

refers to selling off part of a firm's operations. In some cases, divestment reverses a forward vertical integration strategy, such as when Ford sold Hertz.

operational relatedness

sharing activities between businesses

liquidation

shutting down portions of a firms operations, often at a tremendous financial loss.

high industry growth rate, low relative market share

stars should be funded and encouraged to grow

value reducing diversification: managerial motives

top level executives may diversify in order to diversity their own employment risk, as long as profitability does not suffer excessively. -diversification adds benefits to top-level managers but not shareholders -this strategy may be held in check by governance mechanisms or concerns for ones reputation

corporate relatedness

transferring core competencies into business

vertical integration

when a firm gets involved in new portions of the value chain -Can be very attractive when a firm's suppliers or buyers have too much power over the firm and are becoming increasingly profitable at the firm's expense -By entering the domain of a supplier or a buyer, executives can reduce or eliminate the leverage that the supplier or buyer has over the firm -Can create risks -Can create complacency ex: this concept gets top billing at american apparel, a firm that describes its business model as "vertically integrated manufacturing". the elements of their integrated process for designing, manufacturing, wholesaling, and selling basic t-shirts, underwear, etc are shown here: -manufacturing is conducted in a 800,000 square foot factory in downtown los angeles. -ironically, it was a canadian names Dov Charney who founded American Apparel in 1989 -the vertical integration process allows the company to keep pace with the fast moving world of fashion. it takes just a couple of weeks to go from idea to retail floor.

acquisition

when one company purchases another company. one firm buys a controlling, 100 percent interest in another firm with the intent of making the acquired firm a subsidiary business within its portfolio (a larger firm purchases and absorbs a smaller firm)

Spin-off

which involves creating a new company whose stock is owned by investors (ex:GM stockholders received 0.69893 shares of Delphi for every share of stock they owned in GM)