chapter 6 - corporate level strategy

Question 1

acquisitions

Answer 1

Many acquisitions ultimately result in divestiture—an admission that things didn’t work out as planned. In fact, some years ago, a writer for Fortune magazine lamented, “Studies show that 33 percent to 50 percent of acquisitions are later divested, giving corporate marriages a divorce rate roughly comparable to that of men and women

Question 2

diversification movves

Answer 2

Clearly, not all diversification moves, including those involving mergers and acquisitions, erode performance.

For example, acquisitions in the oil industry, such as British Petroleum’s purchases of Amoco and Arco, performed well, as did the Exxon-Mobil merger. T-Mobile’s merger with Sprint also created value for shareholders, with T-Mobile’s stock price rising over 50 percent in the year following the merger. With this merger, T-Mobile was able to leverage Sprint’s bandwidth and accelerate its rollout of 5G technology”

Question 3

Why do some diversification efforts pay off and others produce poor results?

Answer 3

this chapter addresses two related issues:
(1) What businesses should a corporation compete in? and
(2) How should these businesses be managed to jointly create more value than if they were freestanding units

Question 4

diversification initiatives

Answer 4

whether through mergers and acquisitions, strategic alliances and joint ventures, or internal development—must be justified by the creation of value for shareholders. But this is not always the case. Acquiring firms typically pay high premiums when they acquire a target firm

Question 5

Given the seemingly high inherent downside risks and uncertainties, one might ask: Why should companies even bother with diversification initiatives?

Answer 5

The answer, in a word, is synergy, derived from the Greek word synergos, which means “working together.” This can have two different, but not mutually exclusive, meanings.”

Question 6

Why should companies even bother with diversification initiatives?

1. a firm may diversify into related businesses

Answer 6

synergy

First, a firm may diversify into related businesses. Here, the primary potential benefits to be derived come from horizontal relationships, that is, businesses sharing intangible resources (e.g., core competencies such as marketing) and tangible resources (e.g., production facilities, distribution channels). Firms can also enhance their market power via pooled negotiating power and vertical integration.”

“The degree of relatedness of business units can vary widely. A firm’s diversification is related linked when the business units only share a few resources.

In contrast, a firm’s diversification is related constrained when there are a large number of resource links between the business units. The larger number of resource links in related constrained diversification means there is greater potential value to extract from the diversification, but it also means that the member businesses are constrained in the actions they can take to win in each of their markets since any action one business unit takes affects the other business units in the firm.

Question 7

related linked and related constrained

Answer 7

The degree of relatedness of business units can vary widely. A firm’s diversification is related linked when the business units only share a few resources.
For example, Nike shares the Nike brand and the swoosh logo across a number of its businesses but few other resources.

In contrast, a firm’s diversification is related constrained when there are a large number of resource links between the business units.
The larger number of resource links in related constrained diversification means there is greater potential value to extract from the diversification, but it also means that the member businesses are constrained in the actions they can take to win in each of their markets since any action one business unit takes affects the other business units in the firm.

Question 8

Why should companies even bother with diversification initiatives?

2. a corporation may diversify into unrelated businesses.

Answer 8

Second, a corporation may diversify into unrelated businesses. Here the primary potential benefits are derived largely from hierarchical relationships, that is, value creation derived from the corporate office. Examples of the latter would include leveraging some of the support activities in the value chain that we discussed in Chapter 3, such as information systems or human resource practices

Be aware that such benefits derived from horizontal (related diversification) and hierarchical (unrelated diversification) relationships are not mutually exclusive

Question 9

Creating value through related and unrelated diversification:
related diversification - economies of scope

ON EXAM 6 Qs

Answer 9

leveraging core competencies
> 3M leverages its competencies in adhesives technologies to many industries, including automotive, construction and telecommunications

sharing activities
> polaris, a manufacturer of snowmobiles, motorcycles and off-road vehicles, shares manufacturing operations across its businesses. it also has a corporate r&d facility and staff departments that support all of polaris’ operating divisions

Question 10

Creating value through related and unrelated diversification:
related diversification - market power

ON EXAM 6 Qs

Answer 10

pooled negotiating power
> conAgra, a diversified poof produced, increases its power over suppliers by centrally purchasing huge quantities of packaging materials for all of its food divisions

vertical integration
> shaw industries, a leading carpet manufacturer, increases its control over raw materials by producing much of its own polypropylene fiber, a key input to its manufacturing process

Question 11

Creating value through related and unrelated diversification:
unrelated diversification -parenting, restructuring and financial synergies

ON EXAM 6 Qs

Answer 11

corporate restructuring and parenting
> KKR, a private equity firm, uses a small army of in house consultants, called KKE capstone, which advises companies KKR owns on cost savings efforts and growth plans

portfolio management
> novartis, formerly Ciba-Geigy, uses portfolio mgmt to improve many key activities, including resource allocation and reward and evaluation systems

Question 12

Related diversification

(Explain how corporations can use related diversification to achieve synergistic benefits through economies of scope and market power.)

Answer 12

Related diversification enables a firm to benefit from horizontal relationships across different businesses in the diversified corporation by leveraging core competencies and sharing activities (e.g., production and distribution facilities). This enables a corporation to benefit from economies of scope.

Question 13

Economies of scope

Answer 13

refers to cost savings from leveraging core competencies or sharing related activities among businesses in the corporation. A firm can also enjoy greater revenues if two businesses attain higher levels of sales growth combined than either company could attain independently

Question 14

leveraging core competencies

Answer 14

The concept of core competencies can be illustrated by the imagery of the diversified corporation as a tree.

The trunk and major limbs represent core products; the smaller branches are business units; and the leaves, flowers, and fruit are end products.
The core competencies are represented by the root system, which provides nourishment, sustenance, and stability.
Managers often misread the strength of competitors by looking only at their end products, just as we can fail to appreciate the strength of a tree by looking only at its leaves. Core competencies may also be viewed as the glue that binds existing businesses together or as the engine that fuels new business growth.

Question 15

core competencies

Answer 15

Core competencies reflect the collective learning in organizations—how to coordinate diverse production skills, integrate multiple streams of technologies, and market diverse products and services. Casio, a giant electronic products producer, synthesizes its abilities in miniaturization, microprocessor design, material science, and ultrathin precision castings to produce digital watches.

Question 16

For a core competence to create value and provide a viable basis for synergy among the businesses in a corporation, it must meet three criteria:

Answer 16

1. The core competence must enhance competitive advantage(s) by creating superior customer value.
   > Every value-chain activity has the potential to provide a viable basis for building on a core competence.
2. Different businesses in the corporation must be similar in at least one important way related to the core competence.
   > It is not essential that the products or services themselves be similar. Rather, at least one element in the value chain must require similar skills in creating competitive advantage if the corporation is to capitalize on its core competence.
3. The core competencies must be difficult for competitors to imitate or find substitutes for.
   > As we discussed in Chapter 5, competitive advantages will not be sustainable if the competition can easily imitate or substitute them. Similarly, if the skills associated with a firm’s core competencies are easily imitated or replicated, they are not a sound basis for sustainable advantages

Question 17

sharing activities

Answer 17

Recall how leveraging core competencies involves transferring accumulated skills and expertise across business units in a corporation.

Corporations also can achieve synergy by sharing activities across their business units. These include value-creating activities such as common manufacturing facilities, distribution channels, and sales forces. As we will discuss, sharing activities can potentially provide two primary payoffs: cost savings and revenue enhancements

Question 18

deriving cost savings

Answer 18

typically, this is the most common type of synergy and the easiest to estimate. Peter Shaw, head of mergers and acquisitions at the British chemical and pharmaceutical company ICI, refers to cost savings as “hard synergies” and contends that the level of certainty of their achievement is quite high.

Cost savings come from many sources, including from the elimination of jobs, facilities, and related expenses that are no longer needed when functions are consolidated and from economies of scale in purchasing. Cost savings are generally highest when one company acquires another from the same industry in the same country

Question 19

sharing activities

Answer 19

inevitably involve costs that the benefits must outweigh such as the greater coordination required to manage a shared activity. Even more important is the need to compromise on the design or performance of an activity so that it can be shared

Question 20

acquiring firm

Answer 20

Often an acquiring firm and its target may achieve a higher level of sales growth together than either company could on its own.

For example, Starbucks has acquired a number of small firms, including Teavana, a tea producer, and Evolution Fresh, a juice company. Starbucks added value to these brands by expanding their market exposure as Starbucks offers these products for sale in its national retail chain and also through retailers that carry Starbucks products

Question 21

Firms also can enhance the effectiveness of their differentiation strategies by means of

Answer 21

sharing activities among business units.

A shared order-processing system, for example, may permit new features and services that a buyer will value. As another example, financial service providers strive to provide differentiated bundles of services to customers

Question 22

As a cautionary note, managers must keep in mind that sharing activities among businesses in a corporation can

Answer 22

have a negative effect on a given business’s differentiation.

For example, when Ford owned Jaguar, customers experienced lower perceived value of Jaguar automobiles when they learned that the entry-level Jaguar shared its basic design with and was manufactured in the same production plant as the Ford Mondeo, a European midsize car.

Question 23

Related diversification: market power

Answer 23

We now discuss how companies achieve related diversification through market power.

We also address the two principal means by which firms achieve synergy through market power: pooled negotiating power and vertical integration.

Managers do, however, have limits on their ability to use market power for diversification, because government regulations can sometimes restrict the ability of a business to gain very large shares of a particular market.

Question 24

pooled negotiating power

Answer 24

Similar businesses working together or the affiliation of a business with a strong parent can strengthen an organization’s bargaining position relative to suppliers and customers and enhance its position vis-à-vis competitors.

When acquiring related businesses, a firm’s potential for pooled negotiating power vis-à-vis its customers and suppliers can be very enticing. However, managers must carefully evaluate how the combined businesses may affect relationships with actual and potential customers, suppliers, and competitors.

For example, when Netflix diversified into developing its own shows and movies, competitors, such as Disney and Warner Brothers, decided to stop distributing their own shows and movies through Netflix’s distribution system

Question 25

Vertical integration

Answer 25

Vertical integration occurs when a firm becomes its own supplier or distributor. That is, it represents an expansion or extension of the firm by integrating preceding or successive production processes.19 The firm incorporates more processes toward the original source of raw materials (backward integration) or toward the ultimate consumer (forward integration).

For example, an oil refinery might secure land leases and develop its own drilling capacity to ensure a constant supply of crude oil. Or it could expand into retail operations by owning or licensing gasoline stations to guarantee customers for its petroleum products

Question 26

Simplified stages of vertical integration

Answer 26

raw materials > manufacuring of final product > distribution

< backward
> forward

backward integration involves buying part of the supply chain that occurs prior to the company’s manufacturing process,
while forward integration involves buying part of the process that occurs after the company’s manufacturing process

Question 27

Benefits and risk of vertical integration

Answer 27

Vertical integration is a means for an organization to reduce its dependence on suppliers or its channels of distribution to end users. However, the benefits associated with vertical integration—backward or forward—must be carefully weighed against the risks

Question 28

ON EXAM

Benefits and risks of vertical integration

Answer 28

benefits
- a secure source of raw materials or distribution channels
- protection of and control over valuable assets
- proprietary access to new technologies developed by the unity
- simplified procurement and administrative procedures

risks
- costs and expenses associated with increased overhead and capital expenditures
- loss of flexibility resulting from large investments
- problems associated with unbalanced capacities along the value chain (ex: in house-supplier has to be larger than your needs in order to benefit from economies of scale in that market)
- additional administrative costs associated with managing a more complex set of activities

Question 29

In making vertical integration decisions, five issues should be considered

Answer 29

1. Is the company satisfied with the quality of the value that its present suppliers and distributors are providing?
   - If the performance of organizations in the vertical chain—both suppliers and distributors—is satisfactory, it may not, in general, be appropriate for a company to perform these activities itself
2. Are there activities in the industry value chain presently being outsourced or performed independently by others that are a viable source of future profits?
   - Even if a firm is outsourcing value-chain activities to companies that are doing a credible job, it may be missing out on substantial profit opportunities.
3. Is there a high level of stability in the demand for the organization’s products?
   - High demand or sales volatility is not conducive to vertical integration. With the high level of fixed costs in plant and equipment as well as operating costs that accompany endeavors toward vertical integration, widely fluctuating sales demand can either strain resources (in times of high demand) or result in unused capacity (in times of low demand)
4. Does the company have the necessary competencies to execute the vertical integration strategies?
   - As many companies would attest, successfully executing strategies of vertical integration can be very difficult.
5. Will the vertical integration initiative have potential negative impacts on the firm’s stakeholders?
   - Managers must carefully consider the impact that vertical integration may have on existing and future customers, suppliers, and competitor

Question 30

analyzing Vertical Integration: The Transaction Cost Perspective

Answer 30

Another approach that has proved very useful in understanding vertical integration is the transaction cost perspective.

According to this perspective, every market transaction involves some transaction costs

First, a decision to purchase an input from an outside source leads to search costs (i.e., the cost to find where it is available, the level of quality, etc.).

Second, there are costs associated with negotiating. Third, a contract needs to be written spelling out future possible contingencies. Fourth, parties in a contract have to monitor each other.

Finally, if a party does not comply with the terms of the contract, there are enforcement costs. Transaction costs are thus the sum of search costs, negotiation costs, contracting costs, monitoring costs, and enforcement costs. These transaction costs can be avoided by internalizing the activity, in other words, by producing the input in-house

Question 31

transaction-specific investments

Answer 31

A related problem with purchasing a specialized input from outside is the issue of transaction-specific investments. For example, when an automobile company needs an input specifically designed for a particular car model, the supplier may be unwilling to make the investments in plant and machinery necessary to produce that component for two reasons.

First, the investment may take many years to recover but there is no guarantee the automobile company will continue to buy from the supplier after the contract expires, typically in one year.
Second, once the investment is made, the supplier has no bargaining power. That is, the buyer knows that the supplier has no option but to supply at ever-lower prices because the investments were so specific that they cannot be used to produce alternative products.

Question 32

vertical integration

Answer 32

Vertical integration, however, gives rise to a different set of costs. These costs are referred to as administrative costs.

Coordinating different stages of the value chain now internalized within the firm causes administrative costs to go up. Decisions about vertical integration are, therefore, based on a comparison of transaction costs and administrative costs

Question 33

unrelated diversification

Answer 33

With unrelated diversification, unlike related diversification, few benefits are derived from horizontal relationships—that is, the leveraging of core competencies or the sharing of activities across business units within a corporation.

Question 34

vertical (or hierarchical) relationships

Answer 34

instead, potential benefits can be gained from vertical (or hierarchical) relationships—the creation of synergies from the interaction of the corporate office with the individual business units. There are two main sources of such synergies.

First, the corporate office can contribute to “parenting” and restructuring of (often acquired) businesses.
Second, the corporate office can add value by viewing the entire corporation as a family, or portfolio, of businesses and allocating resources to optimize corporate goals of profitability, cash flow, and growth.
Additionally, the corporate office enhances value by establishing appropriate human resource practices and financial controls for each of its business units

Question 35

Corporate parenting and restructuring

Answer 35

within business units as a result of the expertise and support provided by the corporate office

Parenting - The positive contributions of the corporate office are called the “parenting advantage.” Many firms have successfully diversified their holdings without strong evidence of the more traditional sources of synergy (i.e., horizontally across business units).
-> Diversified public corporations such as Berkshire Hathaway and Virgin Group and leveraged buyout firms such as KKR and Clayton, Dubilier & Rice are a few examples.

Restructuring - Restructuring is another means by which the corporate office can add value to a business. The central idea can be captured in the real estate phrase “Buy low and sell high.” Here, the corporate office tries to find either poorly performing firms with unrealized potential or firms in industries on the threshold of significant, positive change.
-> The parent intervenes, often selling off parts of the business; changing the management; reducing payroll and unnecessary sources of expenses; changing strategies; and infusing the company with new technologies, processes, reward systems, and so forth

Question 36

Restructuring can involve changes in

Answer 36

ssets, capital structure, or management

Asset restructuring involves the sale of unproductive assets, or even whole lines of businesses, that are peripheral. In some cases, it may even involve acquisitions that strengthen the core business.

Capital restructuring involves changing the debt-equity mix, or the mix between different classes of debt or equity. Although the substitution of equity with debt is more common in buyout situations, occasionally the parent may provide additional equity capital.

Management restructuring typically involves changes in the composition of the top management team, organizational structure, and reporting relationships. Tight financial control, rewards based strictly on meeting short- to medium-term performance goals, and reduction in the number of middle-level managers are common steps in management restructuring. In some cases, parental intervention may even result in changes in strategy as well as infusion of new technologies and processes

Question 37

portfolio management

Answer 37

During the 1970s and early 1980s, several leading consulting firms developed the concept of portfolio management to achieve a better understanding of the competitive position of an overall portfolio (or family) of businesses, to suggest strategic alternatives for each of the businesses, and to identify priorities for the allocation of resources

However, recent research has suggested that strategically channeling resources to units with the most promising prospects can lead to corporate advantage

However, firms that assess the attractiveness of markets in which the firm competes and the capabilities of each division and then choose allocations of corporate resources based on these assessments exhibit higher levels of corporate survival, overall corporate performance, stock market performance, and the performance of individual business units within the corporation

Question 38

portfolio management (description and potential benefits)

Answer 38

The key purpose of portfolio models is to assist a firm in achieving a balanced portfolio of businesses.

This consists of businesses whose profitability, growth, and cash flow characteristics complement each other and adds up to a satisfactory overall corporate performance. Imbalance, for example, could be caused either by excessive cash generation with too few growth opportunities or by insufficient cash generation to fund the growth requirements in the portfolio

Question 39

Boston Consulting Group’s (BCG’s)

Answer 39

the Boston Consulting Group’s (BCG’s) growth/share matrix is among the best known of these approaches.

In the BCG approach, each of the firm’s strategic business units (SBUs) is plotted on a two-dimensional grid in which the axes are relative market share and industry growth rate. The grid is broken into four quadrants

Question 40

BCG Matrix

Answer 40

industry growth rate (y)
relative market shares (x)

TL - stars
TR - question marks
BL - cash cows
BR - dogs

1. “Each circle represents one of the corporation’s business units. The size of the circle represents the relative size of the business unit in terms of revenues.
2. Relative market share, measured by the ratio of the business unit’s size to that of its largest competitor, is plotted along the horizontal axis.
3. Market share is central to the BCG matrix. This is because high relative market share leads to unit cost reduction due to experience and learning curve effects and, consequently, superior competitive position.”

Question 41

In using portfolio strategy approaches, a corporation tries to create shareholder value in a number of ways.

Answer 41

First, portfolio analysis provides a snapshot of the businesses in a corporation’s portfolio. Therefore, the corporation is in a better position to allocate resources among the business units according to prescribed criteria (e.g., use cash flows from the cash cows to fund promising stars).

Second, the expertise and analytical resources in the corporate office provide guidance in determining what firms may be attractive (or unattractive) acquisitions.

Third, the corporate office is able to provide financial resources to the business units on favorable terms that reflect the corporation’s overall ability to raise funds.

Fourth, the corporate office can provide high-quality review and coaching for the individual businesses.

Fifth, portfolio analysis provides a basis for developing strategic goals and reward/evaluation systems for business managers.
For example, managers of cash cows would have lower targets for revenue growth than managers of stars, but the former would have higher threshold levels of profit targets on proposed projects than the managers of star businesses.

Question 42

limitations of using porfilio strategy

Answer 42

Despite the potential benefits of portfolio models, there are also some notable downsides.

First, they compare SBUs on only two dimensions, making the implicit but erroneous assumption that (1) those are the only factors that really matter and (2) every unit can be accurately compared on that basis.

Second, the approach views each SBU as a stand-alone entity, ignoring common core business practices and value-creating activities that may hold promise for synergies across business units.

Third, unless care is exercised, the process becomes largely mechanical, substituting an oversimplified graphical model for the important contributions of the CEO’s (and other corporate managers’) experience and judgment.

Fourth, the reliance on strict rules regarding resource allocation across SBUs can be detrimental to a firm’s long-term viability. Finally, while colorful and easy to comprehend, the imagery of the BCG matrix can lead to some troublesome and overly simplistic prescriptions.”

Question 43

portfolio strategy

Caveat: Is risk reduction a viable goal of diversification?

Answer 43

“One of the purposes of diversification is to reduce the risk that is inherent in a firm’s variability in revenues and profits over time. That is, if a firm enters new products or markets that are affected differently by seasonal or economic cycles, its performance over time will be more stable. For example, a firm manufacturing lawn mowers may diversify into snowblowers to even out its annual sales. Or a firm manufacturing a luxury line of household furniture may introduce a lower-priced line since affluent and lower-income customers are affected differently by economic cycles”
–> At first glance this reasoning may make sense, but there are some problems with it.
First, a firm’s stockholders can diversify their portfolios at a much lower cost than a corporation, and they don’t have to worry about integrating the acquisition into their portfolio.
Second, economic cycles as well as their impact on a given industry (or firm) are difficult to predict with any degree of accuracy.

Risk reduction in and of itself is rarely viable as a means to create shareholder value. It must be undertaken with a view of a firm’s overall diversification strategy.”

Question 44

three basic means to achieved desired benefits of achieving synergy and creating value for shareholders (through diversification)

Answer 44

1. mergers and acquisitions
2. joint ventures/strategic alliances
3. internal development

First, through acquisitions or mergers, corporations can directly acquire a firm’s assets and competencies. Although the terms mergers and acquisitions are used interchangeably, there are some key differences. With acquisitions, one firm buys another through a stock purchase, cash, or the issuance of debt. Mergers, on the other hand, entail a combination or consolidation of two firms to form a new legal entity. Mergers are relatively rare and entail a transaction among two firms on a relatively equal basis.

Second, corporations may agree to pool the resources of other companies with their resource base, commonly known as a joint venture or strategic alliance. Although these two forms of partnerships are similar in many ways, there is an important difference. Joint ventures involve the formation of a third-party legal entity where the two (or more) firms each contribute equity, whereas strategic alliances do not.

Third, corporations may diversify into new products, markets, and technologies through internal development. Called corporate entrepreneurship, it involves the leveraging and combining of a firm’s own resources and competencies to create synergies and enhance shareholder value”

Question 45

mergers and acquisition - governmental policies and currency fluctuations

Answer 45

Governmental policies such as regulatory actions and tax policies can also make the M&A environment more or less favorable. For example, increased antitrust enforcement will decrease the ability of firms to acquire their competitors or possibly firms in closely related markets. In contrast, increased regulatory pressures for good corporate governance may leave boards of directors more open to acquisition offers.

Finally, currency fluctuations can influence the rate of cross-border acquisitions, with firms in countries with stronger currencies being in a stronger position to acquire. For example, the U.S. dollar increased in value from .83 to .91 euro from early 2021 to early 2022, making it relatively cheaper for U.S. firms to acquire European firms

Question 46

Mergers and acquisitions also can be a means of

Answer 46

obtaining valuable resources that can help an organization expand its product offerings and services.

Alphabet, Google’s parent corporation, has undertaken over 130 acquisitions in the last decade. Alphabet uses these acquisitions to quickly add new technology to its product offerings to meet changing customer needs.

Question 47

Mergers and acquisitions also can provide the opportunity for firms to attain the three bases of synergy

Answer 47

leveraging core competencies, sharing activities, and building market power.

Consider some of eBay’s acquisitions. eBay has purchased a range of businesses in related product markets, such as GSI Commerce, a company that designs and runs online shopping sites for brick-and-mortar retailers, and StubHub, an online ticket broker.

Question 48

Merger and acquisition activity also can lead to

Answer 48

onsolidation within an industry and can force other players to merge.

The airline industry has seen a great deal of consolidation in the last several years. With a number of large-scale acquisitions, including Delta’s acquisition of Northwest Airlines in 2008, United’s acquisition of Continental in 2010, and American’s purchase of US Airways in 2013, the U.S. airlines industry has been left with only four major players.

Question 49

what can mergers and acquisitions do? (3)

Answer 49

Mergers and acquisitions also can be a means of obtaining valuable resources that can help an organization expand its product offerings and services.

Mergers and acquisitions also can provide the opportunity for firms to attain the three bases of synergy—leveraging core competencies, sharing activities, and building market power.

Merger and acquisition activity also can lead to consolidation within an industry and can force other players to merge.

Question 50

Benefits of mergers and acquisitions

Answer 50

Obtain valuable resources, such as critical human capital, that can help an organization expand its product offerings.

Provide the opportunity for firms to attain three bases of synergy: leveraging core competencies, sharing activities, and building market power.

Lead to consolidation within an industry and force other players to merge.

Enter new market segments

Question 51

Research by McKinsey highlights four practices central to effective acquisition integration.

Answer 51

Protecting the base business.
- It is important to not let business managers get distracted by the integration and lose focus on maintaining success in each of their markets.”

“Accelerate capturing value.
- Most acquisitions involve potential efficiency gains from economies of scope, market power, and/or restructuring. Successful acquirers estimate these potential savings in detail and develop information, control, and incentive systems to capture these value gains.”

“Institutionalizing new ways of operating.
- Sixty percent of acquirers reported that they wished they had spent more effort on culture and change management.”

“Catalyzing the transformation.
- Management must be willing to commit full effort to the change. This involves making the necessary structural changes, sticking with the integration for the time needed, and adding new elements as needed.”

Question 52

Potential Limitations: mergers and acquisitions

Answer 52

First, the takeover premium paid for an acquisition is typically very high. Two times out of three, the stock price of the acquiring company falls once the deal is made public.”

“Second, competing firms often can imitate any advantages realized or copy synergies that result from the M&A.44 Thus, a firm can often see its advantages quickly erode. Unless the advantages are sustainable and difficult to copy, investors will not be willing to pay a high premium for the stock. Similarly, the time value of money must be factored into the stock price. M&A costs are paid up front

Third, managers’ credibility and ego can sometimes get in the way of sound business decisions. If the M&A does not perform as planned, managers who pushed for the deal find their reputation tarnished. This can lead them to protect their credibility by funneling more money, or escalating their commitment, into an inevitably doomed operation.”

“Fourth, there can be many cultural issues that may doom the intended benefits from M&A endeavors. Consider the insights of Joanne Lawrence, who played an important role in the merger between SmithKline and the Beecham Group”

Question 53

limitations of mergers and acquisitions summed up

Answer 53

• takeover premiums paid for acquisitions are typically very high
• competing firms often can imitate any advantage or copy synergies that result from the merger or acquisition
• managers’ egos sometimes get in the way of sound business decisions
• cultural issues may doom the intended benefits from M&A endeavors

Question 54

Divestment: The Other Side of the M&A Coin

Answer 54

Divestments, the exit of a business from a firm’s portfolio, are quite common. One study found that large, prestigious U.S. companies divested more acquisitions than they kept.46
Divesting a business can accomplish many different objectives.* It can be used to help a firm reverse an earlier acquisition that didn’t work out as planned.

Often, this is simply to help cut their losses.
Other objectives include
(1) enabling managers to focus their efforts more directly on the firm’s core businesses,
(2) providing the firm with more resources to spend on more attractive alternatives, and
(3) raising cash to help fund existing businesses

Question 55

The Boston Consulting Group has identified seven principles for successful divestiture.

Answer 55

1. Remove the emotion from the decision
2. Know the value of the business you are selling
3. Time the deal right.
4. Maintain a sizable pool of potential buyers
5. Tell a story about the deal.
6. Run divestitures systematically through a project office.
7. Communicate clearly and frequently.

Question 56

strategic alliance

Answer 56

A strategic alliance is a cooperative relationship between two (or more) firms.

Alliances can exist in multiple forms. Contractual alliances are simply based on written contracts between firms. Contractual alliances are typically used for fairly simple alliance agreements, such as supplier, marketing, or distribution relationships that don’t require a great deal of integration or technology sharing between firms and have a finite, identifiable end time period.

Question 57

joint ventures

Answer 57

joint ventures represent a special case of alliances, wherein two (or more) firms contribute equity to form a new legal entity

Question 58

joint ventures - among these are entering new markets, reducing manufacturing (or other) costs in the value chain, and developing and diffusing new technologies.

Answer 58

1. Entering New Markets -
   - Often a company with a successful product or service wants to introduce it into a new market. However, it may not have the financial resources or the requisite marketing expertise because it does not understand customer needs, know how to promote the product, or have access to the proper distribution channels”
2. “Reducing Manufacturing (or Other) Costs in the Value Chain
   - Strategic alliances (or joint ventures) often enable firms to pool capital, value-creating activities, or facilities in order to reduce costs. For example, the PGA and LPGA tours joined together in a strategic alliance that allows them to save costs by jointly marketing golf, develop a shared digital media platform, and jointly negotiate domestic television contracts.
3. Developing and Diffusing New Technologies
   - Strategic alliances also may be used to build jointly on the technological expertise of two or more companies. This may enable them to develop products technologically beyond the capability of the companies acting independently

Question 59

joint ventures - potential downsides

Answer 59

Despite their promise, many alliances and joint ventures fail to meet expectations for a variety of reasons.
First, without the proper partner, a firm should never consider undertaking an alliance, even for the best of reasons.

Each partner should bring the desired complementary strengths to the partnership. Ideally, the strengths contributed by the partners are unique; thus synergies created can be more easily sustained and defended over the longer term.

The goal must be to develop synergies between the contributions of the partners, resulting in a win–win situation. Moreover, the partners must be compatible and willing to trust each other

Question 60

internal development

Answer 60

Firms can also diversify by means of corporate entrepreneurship and new venture development. In today’s economy, internal development is such an important means by which companies expand their businesses that we have devoted a whole chapter to it

Question 61

managerial motives that can serve to erode value creation - growth for growth’s sake

Answer 61

Research suggests that underpaid CEOs are especially driven to pursue acquisitions in order to grow their firms. When CEOs receive less pay than peers running similar firms, they are more likely to acquire. Further, they more frequently use stock rather than cash to finance those acquisitions. When stock is used to finance an acquisition, the shareholders of the acquiring and target firms share both the gains that will occur if the acquisition generates value over time and losses if the acquisition destroys value. Thus, the use of stock indicates that managers see significant risk with the acquisition.

This suggests that underpaid CEOs who undertake acquisitions to grow the firm understand that these acquisitions are risky for the acquiring firm. Still, these acquisitions serve their purpose for underpaid CEOs. The pay forunderpaid acquiring CEOs typically rises substantially in the following year

Question 62

managerial motives that can serve to erode value creation - egotism

Answer 62

“A healthy ego helps make a leader confident, clearheaded, and able to cope with change. CEOs, by their very nature, are intensely competitive people in the office as well as in their personal lives. But sometimes when pride is at stake, individuals will go to great lengths to win.

Question 63

managerial motives that can serve to erode value creation - antitakeover tactics

Answer 63

1. greenmail
2. golden parachute
3. poison pills

Unfriendly or hostile takeovers can occur when a company’s stock becomes undervalued. A competing organization can buy the outstanding stock of a takeover candidate in sufficient quantity to become a large shareholder. Then it makes a tender offer to gain full control of the company. If the shareholders accept the offer, the hostile firm buys the target company and either fires the target firm’s management team or strips the team members of their power.

Question 64

antitakeover tactics - greenmail

Answer 64

The first, greenmail, is an effort by the target firm to prevent an impending takeover. When a hostile firm buys a large block of outstanding target company stock and the target firm’s management feels that a tender offer is impending, it offers to buy the stock back from the hostile company at a higher price than the unfriendly company paid for it. Although this often prevents a hostile takeover, the same price is not offered to preexisting shareholders. However, it protects the jobs of the target firm’s management.

Question 65

antitakeover tactics - golden parachute

Answer 65

Second, a golden parachute is a prearranged contract with managers specifying that, in the event of a hostile takeover, the target firm’s managers will be paid a significant severance package. Although top managers lose their jobs, the golden parachute provisions protect their income.

Question 66

antitakeover tactics - poison pills

Answer 66

Third, poison pills are used by a company to give shareholders certain rights in the event of a takeover by another firm. They are also known as shareholder rights plans.”