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
Manufacturing
Distribution
Backward Integration
Forward Integration
Diversification
Vertical IntegrationVertical IntegrationProfessor 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 barriersDown-stream price maintenanceUp-stream power over price
Efficiency (lower cost)Specialized assets & the holdup problemProtecting product qualityImproved scheduling
Managerial Eco. - Rutgers University 6-13
Optimal Input Procurement
Substantial specialized investments relative to contracting costs?
Spot ExchangeNo
Complex contracting environment relative to costs of integration?
Yes
Vertical Integration
Yes
Contract
No
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 developmentDeveloping New Competencies (Stretching)Transferring Core Competencies (Leveraging)
• Utilizing excess capacity (e.g., in distribution)• Economies of Scope • Leveraging Brand-Name (e.g., Haagen-Dazs 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 problemManagerial capitalism (“empire building”)Maximize management compensationSales Growth maximization • Professor William Baumol
DiversificationIssue #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.
DiversificationIssue #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 MatrixThe BCG Matrix
Cell 1: Stars Cell 2: Question Marks
Cell 3: Cash Cows Cell 4: Dogs
High
High
Low
Low
Industry Industry Growth RateGrowth Rate
Relative Market ShareRelative Market Share
Mergers and AcquisitionsA 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.
Ch7-3
Problems inAchieving Success
Problems inProblems inAchieving SuccessAchieving Success
IntegrationIntegrationdifficultiesdifficulties
Inadequate Inadequate evaluation of targetevaluation of target
Too muchToo muchdiversificationdiversification
Large orLarge orextraordinary debtextraordinary debt
Inability toInability toachieve synergyachieve synergy
Managers overlyManagers overlyfocused on acquisitionsfocused on acquisitions
Too largeToo large
IncreasedIncreasedmarket powermarket power
OvercomeOvercomeentry barriersentry barriers
Lower riskLower riskcompared to developing compared to developing
new productsnew products
Cost of newCost of newproduct developmentproduct development
Increased speedIncreased speedto marketto market
IncreasedIncreaseddiversificationdiversification
Avoid excessiveAvoid excessivecompetitioncompetition
AcquisitionsAcquisitions
Reasons forReasons forAcquisitions Acquisitions
20
Attributes of Effective Attributes of Effective AcquisitionsAcquisitions
AttributesAttributes ResultsResults
Complementary Complementary Assets or ResourcesAssets or Resources
Buying firms with assets that meet current Buying firms with assets that meet current needs to build competitivenessneeds to build competitiveness
Friendly Friendly AcquisitionsAcquisitions
Friendly deals make integration go more Friendly deals make integration go more smoothlysmoothly
Careful Selection Careful Selection ProcessProcess
Deliberate evaluation and negotiations are Deliberate evaluation and negotiations are more likely to lead to easy integration and more likely to lead to easy integration and building synergiesbuilding synergies
Maintain Financial Maintain Financial SlackSlack
Provide enough additional financial Provide enough additional financial resources so that profitable projects would resources so that profitable projects would not be foregonenot be foregone
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:
• 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.