Corporate Level Strategy

CORPORATE LEVEL
STRATEGY
Corporate-level strategy concerns the selection and
management of a mix of businesses competing in several
industries or product markets.

 It is the way a company creates value through the configuration and

coordination of multi-market activities:

 To add economic 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.
 Understanding the Value Chain

Raw Materials

Ba
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In
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Fo
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In
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 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)?
 VERTICAL INTEGRATION
Why vertically integrate?

Market Power (increase revenue)

 Entry barriers
 Down-stream price maintenance
 Up-stream power over price

Efficiency (lower cost)

 Specialized assets & the holdup problem
 Protecting product quality
 Improved scheduling
 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

Risks in undertaking cooperative
agreements or strategic alliances

 Adverse selection
 Partners misrepresent skills, ability and other
resources
 Moral Hazard
 Partners provide lower quality skills and
abilities than they had promised
 Holdup
 Partners exploit the transaction specific
investment made by others in the alliance
 MOTIVATIONS FOR
DIVERSIFICATION
Value Enhancing Motives:

 Increase market power

 Multi-point competition
 R&D and new product development
 Developing New Competencies (Stretching)
 Transferring Core Competencies (Leveraging)

 Utilizing excess capacity (e.g., in distribution)

 Economies of Scope
 Leveraging Brand-Name (e.g., Haagen-Daz to chocolate candy)
 OTHER MOTIVATIONS FOR
DIVERSIFICATION

Motivations that are “Value neutral”:

 Diversification motivated by poor economic performance in current businesses.

Motivations that “Devaluate”:

 Agency problem
 Managerial capitalism (“empire building”)
 Maximize management compensation
 Sales Growth maximization
 Professor William Baumol
 DIVERSIFICATION
Issue #1: When there is a reduction in managerial
(employment) risk, then there is upside and downside effects
for stockholders:

 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 economic

incentive to diversify to a point that is detrimental to
stockholders.
 DIVERSIFICATION
Issue #2: There may be no economic value to stockholders in
diversification moves since stockholders are free to diversify by
holding a portfolio of stocks. 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
economic value.

 Kaiser Industries main assets: (1) Kaiser Steel; (2) Kaiser Aluminum; and (3)
Kaiser Cement 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.
 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
 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.

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.
 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
 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
 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 ofthe winner’s curse.

 The most optimistic bidder usually over-estimates

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?

 Luck

 Asymmetric Information
 This eliminates the competitive bidding premise implicit in the
“efficient market hypothesis”

 Specific-synergies between the bidder and the target.

 Once again this eliminates the competitive bidding premise of
the efficient market hypothesis.