MGT 112

Global Business Strategy

 Overview of the day

1. Quick review of last class

2. Strategic Alliances
1. A Note on Strategic Alliances
2. When to Ally and When to Acquire
3. Case Study: Abgenix
1. A discussion of risk
4. Report 1: group meeting times and feedback
 Review of Last Class – iPhone City

• Local and national policy in China was crafted to attract

and support multinationals to move their manufacturing
there, particularly advanced manufacturing
• This brought the majority of Foxconn’s manufacturing
of Apple products
• As time went on, policy shifted to be less generous
towards these multinationals, likely reflecting the
growing expertise of domestic firms
 Review of Last Class – iPhone City

– Effective global business strategy involves understanding the dynamic relationship

between firms and governments
– This dynamic is defined by their relative power, which is always shifting. An ongoing
repeated negotiation provides the best descriptive framework.
– On the firm side: strategic decision making requires
• Knowledge of the current power dynamic, i.e. what can be achieved
• Knowledge of future power dynamics, i.e. what can be achieved later
• Knowledge of the strategic interests of their partners, i.e. what are the long term results of a decision
– Moving towards more micro examples of power dynamics, navigating interpersonal
relationships and the incentives of influential individuals within organizations is
necessary
– A minor takeaway: always be asking, what exactly is a government getting from big
giveaways?
 Review of Last Class – Strings Attached

– China has been investing billions of dollars in Ecuador through development

loans, in return for access to natural resources and other concessions
– The relationship between wealthy lender nations and loan recipients places
decision makers in developing nations in a bind. It is not easy to determine
whether entering into a debt based relationship is a good idea, and depends
upon the particularities of the deal and (uncertain) projections of future asset
valuations
– From the business strategy perspective, these dynamics provide many risks
and opportunities. For instance, firms in wealthy nations have an interest in
lobbying for their home country to demand contracting their services as a
term for a loan, for instance.
 Review of Last Class – Alshaya Co

• Cheesecake factory is interested in expanding into the Middle

East, due to their reasonable belief that this would be a
massive revenue opportunity
• David Overton is an extremely detail oriented executive who
has contributed to the brand value of CF by ensuring the
exact homogeneity across it’s impressively complex
operation
• The preservation of brand value into an unfamiliar market
presents a large challenge
 Review of Last Class – Alshaya Co

• The value proposition of Alshaya Co is that they allow a firm to

expand to their region when they otherwise wouldn’t be able to
– Scouting offices, leasing, hiring and managing employees, making
culturally appropriate changes
• They are capable of exactly replicating many of the complex
procedures and services associated with a firm, suiting the needs of
CF
• Forming a strategic partnership with Alshaya had many clear
benefits noted in the reading, but remember risks: what are the long
term consequences of information exchange?
 Strategic Alliances

• Big ideas
– Making a correct decision is very difficult, and always
involves uncertainty and dealing with complexity
– We want to have a framework that allows us to see what the
key features of a problem are and make a decision based on
those (reduce noise)
– We want to be explicit and clear about the motivations and
reasoning behind our actions so that we can be sure our
strategy matches up with those
 Strategic Alliances

• Key decision in business strategy is to decide what type of relationship to have with
another firm(s) to achieve a goal
• There are several options, we’ll consider
– Do all the work in-house (no partnership)
– Acquire another firm outright
– Come to a short-term contract
– Make a long-term Strategic Alliance, in which two companies arrange to undertake a mutually
beneficial project while both entities retain their independence. This is a long-term, explicit
agreement between two or more firms.
• These readings provide some theoretical guidance on when it is appropriate to pursue a
strategic alliance
– First reading is going to mostly cover “why would you want one” and the second is more about
“what kind should you want”
 Strategic Alliances

• Fundamental abstract idea of a firm is an entity which

takes inputs and transforms them into outputs to sell
• This process of transformation requires a lot of
activity: acquiring inputs, transforming those inputs,
performing R&D, distribution and marketing, etc.
• Each of those tasks/processes can be accomplished
with different business structures.
 Strategic Alliances

• One overarching theory is to minimize Transaction Costs

– Transaction costs are expenses incurred when buying or selling a good or service.
• This can be a pretty large category of costs and isn’t a super tight definition, but is particularly
related to ideas of uncertainty and friction
– A good example is that if an individual wants to buy a stock, they pay more than just
the value of the stock, for instance in broker’s fees, and that gap is between the price
of the stock and the price paid are transaction costs
– On uncertainty, the costs of time spent shopping around to find the best option are
transaction costs as well
• If firms are interacting frequently with each other or there’s a lot of
uncertainty, they could have high transaction costs and be incentivized to
come to a better arrangement
 Strategic Alliances

• One source of tension between parties in any economic transaction is that

they have unaligned incentives.
– A base example is that a buyer wants a lower price and a seller wants a higher
price. But this can be much more complex.
• Strategic Alliances are a way to align the incentives of various parties
and provide a better outcome than can be done with short term contracts.
• Abstractly, this is because firms reduce risk when they enter long term
contracts, thus they can make cost-efficient forward looking decisions.
– For instance, in the example of a railway trying to decide whether it’s worth the
investment to build towards a coal mine, guaranteed business via a contract leads
to a satisfactory outcome for both firms.
 Strategic Alliances

• However, strategic alliances do not solve the issue of

unaligned incentives as completely as outright acquisition.
• Internalization outright eliminates the possibility of
opportunistic behavior.
• Thus, the fundamental trade-off between strategic alliances
and acquisition is whether the benefits of fully aligned
incentives are worth the costs associated with a merger and
increased governance
 Strategic Alliances

• Why pursue strategic alliances? Generally, it is

because it allows firms to achieve together what they
could not otherwise.
• Motivations include
– Information exchange
– Complementary resources
– Economies of scale
– International expansion
 Strategic Alliances

• To recap:
– Strategic alliances are long-term explicit agreements
between firms which allow them to reduce transaction
costs (either friction or uncertainty) and pool resources
together in some fashion in order to achieve goals they
would not otherwise be able to.
– Further question is what type of strategic alliance should
be pursued? Or should one firm outright acquire the other
(also solving the transaction cost problem)?
 Strategic Alliances

• Data show that despite the clear theoretical value in

alliances/acquisitions, many of them end up failing.
• One plausible explanation is that these seemingly similar strategies
work in very different circumstances, so using the wrong strategy
will lead to failure where the right one would’ve succeeded
• Interesting data shows that despite many survey respondents
agreeing that acquisitions and alliances are different ways of
achieving the same growth goals, less than half of firms actually
considered the alternative approach before choosing one.
 Strategic Alliances

• So, how to decide what type of relationship to

have?
– Nonequity alliance
• Firms stay distinct entities
– Equity alliance
• One firm acquires some part of another
– Acquisition
• One firm fully acquires another
 Strategic Alliances

• Depends upon Synergies

– Modular (manage resources separately, bring together
at end) : Nonequity
– Sequential (one company does its part then passes off
to another firm) : Equity
– Reciprocal (iterative process, very closely aligned) :
Acquisition
 Strategic Alliances

• Resources
– Hard resources (e.g. factories, plants, buildings) are good for
acquisitions because they are very easy to value, stable in value,
and can be quickly integrated
– Soft resources (e.g. people) are better for equity alliances, which
allow for closer monitoring and collaboration but don’t have as
much culture friction
– Redundant resources: large amounts of redundant resources are
good for acquisitions, as they can either lead to economies of scale
or be sold off to reduce costs.
 Strategic Alliances

• Market Factors: uncertainty and competition matter as well

• Uncertainty describes the ability of the firm to forecast the
outcome of a collaboration: the more uncertainty, the more
distant the collaboration (e.g. high uncertainty—non-equity
alliance)
• Competition: if there is high competition (e.g. multiple
suitors), this puts additional pressure on outright
acquisition
Strategic Alliances
 Strategic Alliances

• In your breakout rooms, please discuss the

following prompt:
– Why do you think so many strategic alliances and
acquisitions fail?
– Why do firms still pursue them if so many of them
fail?
 Strategic Alliances

• In your breakout rooms, please discuss the

following prompt:
– Do you think Cheesecake Factory should pursue a
strategic alliance with Alshaya Co or acquire them?
 Strategic Alliances

• Takeaways
– There are many ways for a firm to approach its goals, and
strategic alliances and acquisitions can be appropriate for
achieving some goals so long as the situation is correct (i.e.
the types of synergies, resources, and market factors align)
– Using the wrong approach (i.e. the situation is incorrect) can
lead to a bad outcome
– This provides a general abstract framework for
understanding when to ally or acquire
Break
 Case Study: Abgenix

• Case background:
– XenoMouse is a unique strain of transgenic mouse
created by small firm Abgenix capable of producing
human antibodies
– This makes it incredibly valuable if it can be
successfully brought to market
– Abgenix faces a big question in how to approach
marketing its mouse
 Case Study: Abgenix

• Case background
– Abgenix was licensing out the mouse: companies could
contract upfront for antibodies to hit a disease target,
then pay fees as the program proceeded and even a
share of market revenue
– Abgenix would also pursue early stage drug
development, and then sell off the rights to develop and
sell the drug
 Case Study: Abgenix

• By selling right rights off to drugs, Abegenix was

taking a risk-averse position: they insulated
themselves from the chance that a drug might
ultimately fail, but didn’t get the upside chance of
a huge hit
 Case Study: Abgenix

• This leads to a major turning point, as their cancer drug

was incredibly successful in lab trials
• They faced the decision
– License out to giant Pharmacol, who would pay a good fee and
had a high likelihood of success
– Partner with Biopart, a smaller firm, and share in the potential
costs and profits moving forward
– Do Phase 2 (which would either dramatically raise value or
wipe it out) and then decide
 Case Study: Abgenix

• In break out rooms, please consider the following prompt:

• If you were the CEO of Abgenix, what would you do with
XenoMouse? Would you sell to Pharmacol or Biopart?
– What factors influence your decision, particularly, how do you
feel about such a risky decision, and are their non-monetary
factors (e.g. the excitement of leading an innovative product
over the finish line) that matter to you?
 Risky Decisions

• Almost every decision has some element of risk, that is, the there
are multiple possible outcomes with some attached probability. The
future is infinitely full of uncertainty.
• Economics and Behavioral Economics provide frameworks for
ways to think about risk, either normatively (how people should
think about risk) or descriptively (how people do seem to think
about risk)
• Both agree that whatever the objective description of a risky
situation, an individual’s risk preferences determine how they
subjectively value the risky choice
 Risky Decisions

• The simplest framework for understanding risk is expected

value
• P1V1 + P2V2=EV
• This allows you to compare 2 risky choices: you can calculate
the EV of each choice, and go with the higher value
• No risk preferences here, an individual who is only concerned
with maximizing expected value has an extremely simple
choice so long as they know the potential probabilities and
potential outcomes associated with each choice
 Risky Decisions

• Consider if the choice was:

– Pharmacol has a 90% chance of success, with
100million profits if so. 10% chance of failure, with 50
million profits if so. EV = .9*100+.1*50=95million
– Biopart has a 10% chance of success, with 700 million
in profits if so. 90% chance of failure, with -30 million
if so. EV = .1*700+.9*-30=43 million.
– Very easy with EV!
 Risky Decisions

• What if the EV flipped, and Biopart had higher

EV and Pharmacol was just the safe option?
– Pharmacol has a 90% chance of success, with
50million profits if so. 10% chance of failure, with 45
million profits if so. EV = .9*100+.1*50=49.5million
– Biopart has a 10% chance of success, with 700 million
in profits if so. 90% chance of failure, with -30 million
if so. EV = .1*700+.9*-30=43 million.
 Risky Decisions

• The standard economic approach builds on expected

value with the concept of expected utility
• The important insight of EU in this setting is that
individuals are typically risk averse, in that they will
happily pay a premium to get a sure outcome which
keeps them away from a potentially very bad outcome
• This is a theoretical explanation for insurance markets
Risky Decisions
 Risky Decisions

• Consider your own behavioral intuition about this

question though. Hypothetical outcomes seem to
stand out don’t they?
– Wouldn’t it be awful to gamble on yourself and lose
30million?
– Wouldn’t you feel silly if the drug succeeded and
you’d taken the safe option, foregoing hundreds of
millions?
 Risky Decisions

• The psychological nature of risky decisions is very important

because a firm like Abgenix does not get to make these decisions
over and over again: they do it once and have to live with the
consequences.
• A major firm can pick the highest expected value choice on a
gamble it plays: they don’t care about the potential that any one
gamble fails because they will win in aggregate with this strategy
• Thus, the nature of repeated versus 1 shot gambles leads to
fundamentally different decision making for firms of various size
 Risky Decisions

• The psychological nature of risky decisions is very important

because a firm like Abgenix does not get to make these decisions
over and over again: they do it once and have to live with the
consequences.
• A major firm can pick the highest expected value choice on a
gamble it plays: they don’t care about the potential that any one
gamble fails because they will win in aggregate with this strategy
• Thus, the nature of repeated versus 1 shot gambles leads to
fundamentally different decision making for firms of various size
Break
 Report 1

• Now we’ll take some time for people in groups to

meet up and begin the planning process.
• I’ll drop in on breakout rooms to check in and
help