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

Vertical Integration
Defining Vertical Integration
The number of stages in a products or services
value chain that a particular firm engages in
defines that firms 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.

Understanding the Value Chain

Raw Materials

Manufacturing

Diversification

Distribution

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

Substantial
specialized
investments
relative to
contracting costs?

No

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

IInformal
nformal
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

Relationship Between Firm

Performance and Diversification

Diversification

Capital Market
Intervention and the
Market for
Managerial Talent

Incentives

Diversification
Strategy

Resources

Managerial
Motives

Internal
Governance

Firm
Performance

Strategy
Implementation
34

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 longrun 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

Relationship Between Firm

Performance and Diversification
Incentives

Resources

Managerial
Motives

Capital Market
Intervention and the
Market for
Managerial Talent

Diversification
Strategy

Internal
Governance

Firm
Performance

Strategy
Implementation
34

The BCG Matrix

High Cell 1: Stars

Cell 2: Question Marks

Industry
Growth Rate

Low Cell 3: Cash Cows

Cell 4: Dogs

High

Low

Relative Market Share

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 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 firms 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., BMWs acquisition of Rover

Diversification
e.g., Seagrams acquisition of Universal
Studios
Avoiding Excess Competition
e.g., General Electrics 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., Campeaus 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 Dont 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 TheMcGraw-Hill Companies, Inc. All rights reserved.

6-31

Attributes of Effective
Acquisitions
Attributes

Results

Complementary
Assets or Resources
Friendly
Acquisitions
Careful Selection
Process

Buying firms with assets that meet current

needs to build competitiveness
Friendly deals make integration go more
smoothly
Deliberate evaluation and negotiations are
more likely to lead to easy integration and
building synergies

Maintain Financial
Slack

Provide enough additional financial

resources so that profitable projects would
not be foregone
20

Attributes of Effective
Acquisitions
Attributes

Results

Low-to-Moderate
Debt

Merged firm maintains financial flexibility

Sustain Emphasis
on Innovation

Continue to invest in R&D as part of the

firms overall strategy

Flexibility

Has experience at managing change and is

flexible and adaptable

21

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
winners 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
efficient market hypothesis

(3) Specific-synergies between the bidder

target.

implicit in the

and the

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