Strategic Management/

Business Policy

Joe Mahoney
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.
 Understanding the Value Chain

Raw Materials

Ba
ck
w ar
d
In
te
gr
at
io Manufacturing Diversification
n

Fo
r wa
rd
In
te
gr
at
io
n Distribution
 Summary: Creating Value in Vertical
Activities
Be Better Than Competitors
(1) In determining whether activities should be internal or external:

External Internal Activities External

Supplier Customer

(2) 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 andand 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 P1 P2 P3 A1 A2 A3
SPECIALIZED V2
FIRMS V3

Common Issue--- What are TRANSACTION COSTS of markets

compared with administrative costs of the firm?
 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)?
 Optimal Input Procurement

Spot Exchange
No
Substantial
specialized
investments
relative to Yes Complex contracting
contracting costs? environment relative to
costs of integration?

No Yes

Vertical
Contract Integration

Managerial Eco. - Rutgers University 6-13

 Types of strategic alliance
Strategic alliances

Non-equity alliance Joint Venture

Cooperation between firms
is managed directly through
contracts without cross-
equity holding or an
independent firm being
created
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
Informal
Informal
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 Agreeing to swap

reduced by: valuable skills
and technologies

Seeking credible
commitments
Figure 14.1

© McGraw Hill Companies, Inc., 2000 14-21

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 holdings.
MODE of diversification

Choice of mode of diversification:

Internal development
Acquisition
Joint venture
Licensing
 Relationship Between Firm
Performance and Diversification
Capital Market
Intervention and the
Market for
Managerial Talent
Incentives

Diversification Firm
Resources
Strategy Performance

Managerial
Motives Internal Strategy
Governance 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

High Medium Low

Investment
High Selective
and
Growth Selectivity
Growth

Medium Selective Harvest/

Growth Selectivity
Divest
Business Strength

Harvest/
Harvest/ Harvest/
Harvest/
Low Selectivity Divest Divest
Divest Divest

© 1999 Pankaj Ghemawat

 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.
Reasons for Problems in
Acquisitions Achieving Success
Increased Integration
market power difficulties

Overcome Inadequate
entry barriers evaluation of target

Cost of new Large or

product development extraordinary debt

Increased speed Inability to

to market Acquisitions achieve synergy

Lower risk Too much

compared to developing diversification
new products

Increased Managers overly

diversification 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., 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
 Attributes of Effective
Acquisitions
Attributes Results
Complementary Buying firms with assets that meet current
Assets or Resources needs to build competitiveness
Friendly Friendly deals make integration go more
Acquisitions smoothly
Careful Selection Deliberate evaluation and negotiations are
Process more likely to lead to easy integration and
building synergies
Maintain Financial Provide enough additional financial
Slack resources so that profitable projects would
not be foregone 20
 Attributes of Effective
Acquisitions
Attributes Results
Low-to-Moderate Merged firm maintains financial flexibility
Debt

Sustain Emphasis Continue to invest in R&D as part of the

on Innovation firm’s 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 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