Strategic Management/

Business Policy
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 multi-market 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.
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
 Vertical Integration
• 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)?
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”:

• Growth maximization
• 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
MODE of diversification

• Choice of mode of diversification:

• Internal development
• Acquisition
• Joint venture
• Licensing
 Mergers and Acquisitions
• Increasing use of mergers &
acquisitions

• 1980s: 55,000 M&As: total value $1.3 trillion

• 1998: total value $2.5 trillion
• 1999: total value $3.4 trillion

IN UNITED STATES:
• 1998: total value $1.6 trillion
• 1999: total value $1.75 trillion
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 firm’s bid.
 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
 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.
 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