integration - mergers &...

Advanced Ind. Management Chair Industry, Energy & Environment

| Prof. Wirl SS 2016

Integration - Mergers & Acquisitions

Definitions Horizontal within the same

level of production and industry, e.g. Daimler Benz und Chrysler, UniCredito und HVB

Vertical across the production chain, e.g. power plant and coal mining, refining and oil production, automobiles integrating suppliers (GM&Fisher Body).

Lateral across branches, e.g. General Electric (GE)


Goals

Growth Internal or natural growth is limited to increases in demand and thus

modest in mature industries. External growth through takeovers (friendly & hostile take-overs) allows for

expansion even in saturated markets. Synergies (1+1=3):

More efficient production by eliminating duplications (e.g. in R&D). Better deals with suppliers

Risk diversification Losses in market A may be compensated by gains in market B (another

country, another product, etc.). Remark: However, stock market provides this insurance much better to the investors.



Some examples

Fiat forged a strategic alliance with Chrysler. The Italian carmaker will take a 35% stake in the troubled Detroit company in return for access to its small-engine and transmission technology and international dealerships. The deal throws a lifeline to Chrysler, which risks having to repay an emergency $4 billion loan to the federal government and losing the chance of further help if it cannot provide evidence of a credible turnaround plan. After months of negotiations, Delta Air Lines and Northwest Airlines announced their intention to merge, and so create America's biggest domestic carrier. However, the $3.6 billion all-share deal faces stiff opposition from Northwest's pilots, who have so far failed to reach agreement with their colleagues at Delta about integrating the seniority lists that determine flight assignments. JPMorgan overtook Bear Stearns JPMorgan, which stepped in to rescue its rival during a run on its assets amid bankruptcy rumors.



Some examples

NYSE Euronext and Deutsche Börse agreed to merge. If the deal is consummated it will create the world’s largest trading platform for shares and derivatives. Shareholders in the German exchange will own 60% of the new company, but senior American politicians seemed fairly relaxed about the prospect of the New York Stock Exchange being incorporated in an enterprise where it would hold a minority stake. Speculation mounted that a rival bid for either business could emerge. The long-awaited sale of Ford's Jaguar and Land Rover to Tata Motors was announced; the Indian company is paying around $2.3 billion for the luxury-car brands. Ford acquired Jaguar in 1989 and Land Rover in 2000, but is now restructuring its business around its more basic models. Wrigley, a maker of chewing-gum and mints, accepted a $23 billion takeover from Mars, which includes Snickers, M&M's and Uncle Ben's rice among its brands. The combined company will overtake Cadbury Schweppes to become the world's biggest confectioner. The deal was made possible by funding from Warren Buffett.



Some examples

France's Pernod Ricard buys Vin & Sprit of Sweden “IF WE run, it is to win,” says Patrick Ricard, chairman and chief executive of Pernod Ricard, a French drinks group. In the past four months Mr Ricard has done a lot of running. He wanted to capture Vin & Sprit (V&S), which was put up for sale by the Swedish government in December and owns Absolut, a premium-vodka brand. And he won. On March 31st, Pernod Ricard announced its takeover of V&S for €5.6 billion ($8.9 billion) including debt.

The gloves came off in the bidding war for Corus, an Anglo-Dutch steelmaker. CSN, a steel company based in Brazil, made a formal bid of £4.9 billion ($9.6 billion), trumping a sweetened offer from India's Tata Steel that had been made just hours earlier.



Recent Mergers (sample)

2014 - April




AMR Corporation (American Airline) and US Airways announced plans for a merger in February 2013. Together, the bankrupt AMR corporation and US Airways would be the biggest Airline in the world with revenues of around $38 billion, 6400 flights per day, and about 100.000 employees. The merged company would have a value of about §11 billion. United Airlines & Continental Airlines UAL, the parent company of United Airlines, and Continental Airlines announced that they are to merge in an all-share deal worth around $3 billion. Assuming it gets the go-ahead from competition regulators, the new company, to be called United Continental Holdings, will be the world’s largest airline by passenger numbers. Consolidation in the aviation industry is being driven by continued losses. Airlines lost a combined total of $9.4 billion in 2009 according to IATA, an industry association.



More Recent Mergers (sample)

Schaeffler, a family-owned German firm that triumphed in the hostile takeover of Continental. Now Problems! IBM & Sun (talks) Troubles in the GE conglomerate (in particular in its financial subsidiaries), so long appreciated recently even loosing its AAA rating! Merck is to pay $41 billion for Schering-Plough Heinz & Kraft Nokia & Alcatel-Lucent




Oil firms have started buying each another again WHEN the going gets tough, the solvent get buying. That, roughly, was the philosophy of the titans of the oil industry last time the price of their product plummeted, in the late 1990s. Hunting for oil had become less profitable thanks to the falling price, whereas preying on rivals had become easier, thanks to plunging share prices. Thus Exxon Mobil, Chevron Texaco, BP Amoco and TotalFinaElf were born. So when Suncor and Petro-Canada, two big Canadian oil firms, announced a C$19.3 billion ($15.8 billion) merger on March 23rd, the industry’s biggest since 2006, speculation mounted that another wave of deals might be imminent.



Merger waves

There were massive waves in the 1980s and 1990s too. These merger waves mean that the number of competitors in a market can collapse dramatically in just a few years.



Merger waves



Merger waves recently Economist April 18th, 2015, Buttonwood A zeal for deal, p62.


… takeover booms tend to be associated with periods when stockmarkets are doing well, such as the late 1990s or 2006-07. Executives can use their highly valued shares as currency. In the tech sector, the likes of Google and Facebook can scatter their shares like confetti. Equity-based deals are less risky for the predator, which does not have to saddle its balance-sheet with debts that might prove a dangerous burden in the next recession. But today’s very low level of interest rates also makes life easy for private-equity bidders, which rely mainly on debt. … Managers reason that, if they are not a predator, they will turn into prey. Even more cynical explanations are available. Running a bigger company can justify bigger salaries for executives. A study … found that, in cases where the chief executive of the target company was retained after a merger, the acquirer paid a smaller premium to the initial share price than in other takeovers. That suggests executives are trading away shareholder value in return for personal benefits.


IPOs



Other well known examples

American Airline+US Airways VW+Porsche DaimlerChrysler

Daimler bought Chrysler at $35 billion, and sold it for for 7.4 bill. to Cerberus (private equity comp., Bawag). now an alliance with Fiat.

BMW + Rover General Motors & Fiat AOL + Time-Warner Vodafone + Mannesmann Volvo + Renault (alliance!) Renault and Nissan

Bayrische Hypovereinsbank + Bank Austria + later UniCredit

Compaq + HP PPR (Gucci. YSL) and Puma, etc. VOEST – Böhler-Uddeholm. Air France's alliance with KLM Nokia and Siemens Viacom + Time Warner Intel + Nvidia Procter &Gamble + Colgate Kraft + Sara Lee



All mergers promised and still promise substantial gains from exploiting synergies.

However, KPMG, a consulting firm specializing in international mergers and acquisitions found: “only 17% of the 107 largest deals around the world increased values while 53% destroyed values.” Another example from the history is that ten years after the divestiture of Standard Oil (in 1911) the stock value (of the trust’s constituent companies) quintupled, The Economist, November 13th, 1999. How merger mania has been a disaster for the world's great car manufacturers (The Economist, 10. Sept. 2005, 65-67)



Similarly in the oil industry



Automobile industry

The two biggest consolidation deals in the industry are also the most recent: the takeover of Chrysler by Daimler-Benz in 1998; and the alliance of Renault and Nissan the following year. DaimlerChrysler has been a flop so far. The best justification for the Daimler-Chrysler deal, at the time the world's biggest industrial merger, was the growing cost of electronics systems in luxury cars. Mercedes was the world leader in such sophisticated electronics, but it was not a volume car producer, which meant it laboured with a higher cost base. Daimler's hope was that, by buying Chrysler, it could enter the volume end of the car market in one step, and so spread the costs of new technology over a much bigger output. Daimler and Chrysler together are worth less in stock market terms than Daimler alone was before the merger! The Renault deal acquiring shares in loss making Nissan has paid off. Indeed, Nissan's earnings have been propping up Renault, as the latter has gone through a lean period in the past couple of years, hemmed in by an ageing model range and stagnant markets.



Automobile industry

Ford found a buyer for Aston Martin, ending its 20-year control of the famous luxury-car brand. A consortium led by David Richards, an entrepreneur, and which includes two Kuwaiti investment firms, will pay £439m ($848m) for the British-based carmaker. With Ford trying to claw its way back from massive losses, analysts pondered whether it would need to sell other luxury brands, including Jaguar. (The Economist, March 15th, 2007).



Automobile industry

Divorced, What the sale of Chrysler to a private-equity firm means for America's car industry IT WAS billed as a “merger of equals”, but in the end the participants could not make a go of it and their marriage failed. The break-up announced this week of DaimlerChrysler, a transatlantic carmaker created by the union of Daimler-Benz and Chrysler in 1998, involves the sale of 80.1% of Chrysler to Cerberus Capital Management, a private-equity group, for $7.4 billion—though once everything is accounted for, Cerberus is actually being paid to take the troubled American carmaker off the hands of the German company, which will be renamed Daimler. Hopes were high back in November 1998 when Jürgen Schrempp and Bob Eaton, briefly co-chairmen of DaimlerChrysler, rang the bell at the New York Stock Exchange to announce the start of trading in their company. Mr Schrempp saw the $36 billion acquisition of Chrysler as the foundation of a global alliance that would, he hoped, include tie-ups with Hyundai of South Korea and Mitsubishi of Japan, among others. But his scheme failed and the merger foundered. His successor, Dieter Zetsche, who took over in 2006, was reluctant to abandon Chrysler. The moustachioed and charismatic executive had engineered its brief turnaround during his five-year tenure as its boss, starting in 2000. That the revival did not last long was true to form for Chrysler, which has veered between profit and loss ever since it was established by Walter P. Chrysler in 1924. Today's woes were triggered in large part by last year's soaring petrol prices in America, which is still Chrysler's most important market. Motorists turned their backs on the gas-guzzling pickups and sport-utility vehicles that account for roughly two-thirds of Chrysler's sales. The firm initially ignored the problem and continued to churn out vehicles, storing them in car parks around Detroit and selling them at low prices to car-rental firms. As losses mounted, DaimlerChrysler had to cook up yet another turnaround plan. In February Tom LaSorda, Chrysler's boss, ordered what would become known as the “St Valentine's Day massacre”. His plan called for the loss of 13,000 jobs, the closing of an assembly line in Newark, Delaware, and cuts at other factories.



Automobile industry

But it was not enough for the German side of the company, which had never really warmed to Chrysler. Efforts to link product development at Chrysler and Mercedes-Benz always met with fierce resistance. “It was just like two independent companies simply added together their numbers on the balance sheet, and not much else,” says David Healy, an analyst at Burnham Securities, a brokerage. When Mr Zetsche conceded in February that “all options are on the table” it was clear that the marriage was doomed. Potential suitors immediately lined up, and in recent weeks it seemed that Magna, a Canadian parts firm, had emerged as the favourite. Cerberus clinched the deal, however, mainly because of the speed and certainty with which it will be able to complete the transaction. Daimler will retain a 19.9% stake in Chrysler once the deal closes later this year. The transaction will leave the new Chrysler debt-free. Just over $6 billion of Cerberus's investment will go into the new company. Daimler will cover outstanding debts, grant a $400m loan to the new firm and absorb Chrysler's losses until the sale is completed. This will wipe out the $1.35 billion it will receive from Cerberus, so that it is, in effect, likely to end up paying $670m or so to get rid of Chrysler.



Automobile industry

Spot the difference Why does Cerberus think it can succeed in turning Chrysler around, given that Daimler failed? It has several answers. For one thing, the new company should end up with a BB debt rating, which will reduce its borrowing costs. The injection of cash from Cerberus will give it greater room for manoeuvre as it restructures itself than is available to its cash-strapped American rivals, General Motors (GM) and Ford. And John Snow, a former American treasury secretary and Cerberus's chairman, contends that Chrysler will be far better off as a private company and will be able to take a longer-term view once freed from the need to report quarterly results. Surprisingly, despite its reputation as an axe-wielding, job-slashing cost-cutter, Cerberus is not, so far, talking about more job losses: it says it plans to stick to Mr LaSorda's turnaround plan, and has asked him to stay on to implement it. (He will be joined by Wolfgang Bernhard, Chrysler's former number two, who recently left VW and has been acting as an adviser to Cerberus.) There may be cross-selling and cost-cutting opportunities between Chrysler's finance arm and GMAC, GM's financial-services arm, in which a consortium led by Cerberus bought a 51% stake last year. But most speculation centres on Chrysler's health-care liabilities, estimated at some $18 billion, which the new firm will assume under this week's deal. Industry insiders are betting that Cerberus will press the UAW to accept a health-care deal along the lines of that agreed in December by Goodyear, a tyremaker. That scheme offloaded the management of health-care liabilities to a fund run by the tyremaker's union, unburdening the company. Given that the UAW endorsed the sale to Cerberus this week, some speculate that the outlines of such a deal have already been agreed upon. If such a deal were to be struck between the UAW and Chrysler, GM and Ford would demand something similar. A Goodyear-style deal “might actually be good for the UAW, and give it a raison d'être,” suggests a senior executive at a supplier in Detroit. (The union's membership has declined sharply in the past two decades.) The sale of Chrysler to Cerberus might, in short, lead to an improvement in the fortunes of America's top two carmakers—not just the number three.



Automobile industry General Motors has paid Fiat €1.55 billion to get out of an option that would have forced it to acquire the Italian carmaker outright. THE second-hand car market is relatively transparent. Buyers and sellers have readily available means to put a value on a used set of wheels. On Sunday February 13th a little light was shed on how much it would cost not to buy a second-hand carmaker, in poor condition and with one not-so-careful owner. General Motors and Fiat announced that they had undone a deal that would have forced the American car giant to acquire the 90% of the Italian firm that it did not own. GM will pay Fiat €1.55 billion ($2 billion) to cancel a “put” option that the firms had agreed as part of a tie-up that was concluded in happier times for both car companies. GM can afford this and sees it as worth paying to be rid of a car company that is losing money and market share, and is running out of road. In 2000, GM bought 20% of Fiat Auto, the car making arm of the Fiat industrial conglomerate, for $2.4 billion. In return, Fiat took a 6% stake in the American car giant. At the time GM, the world’s biggest car company, feared being left behind in the merger wave that was sweeping the car industry. Since the DaimlerChrysler merger in 1998, the industry had consolidated rapidly. To become a global force, GM felt it needed the expertise of foreign companies to satisfy the differing tastes of the world’s car buyers and to share development costs. GM’s greatest rival, Ford, was building a global network. In Europe it eventually acquired Jaguar, Volvo and Land Rover. Renault had teamed up with Nissan. DaimlerChrysler would go on to forge alliances with Hyundai of South Korea and Mitsubishi of Japan. GM, fearing that DaimlerChrysler would buy Fiat, resolved to add the Italian firm to its European stable, which already included Opel, Vauxhall and Saab. After the deal went through, Fiat’s then boss, Gianni Agnelli, said that he had turned down an offer of $11 billion for the whole firm in an effort to keep the reins. Fiat was keen to sell because its decline was accelerating. Fiat Auto accounted for some 40% of Fiat Group’s sales but its losses were draining money from the more successful parts of the business. At one time Fiat had accounted for 5% of Italy’s GDP and, by the mid-1980s, it was challenging Volkswagen as the biggest European-owned carmaker. But it had made little impact beyond Europe. Mr Agnelli’s desire to keep control (and stay Italian) led to his firm missing out as other carmakers merged.



Emerging Markets There has been a sharp increase in the number of emerging-market companies acquiring established rich-world businesses and brands (see chart 2), starkly demonstrating that “globalisation” is no longer just another word for “Americanisation”. Within the past year, Budweiser, America’s favourite beer, has been bought by a Belgian-Brazilian conglomerate. And several of America’s leading financial institutions avoided bankruptcy only by going cap in hand to the sovereign-wealth funds (state-owned investment funds) of various Arab kingdoms and the Chinese government. One example of this seismic shift in global business is Lenovo, a Chinese computer-maker. It became a global brand in 2005, when it paid around $1.75 billion for the personal-computer business of one of America’s best-known companies, IBM—including the ThinkPad laptop range beloved of many businessmen. Lenovo had the right to use the IBM brand for five years, but dropped it two years ahead of schedule, such was its confidence in its own brand. It has only just squeezed into 499th place in the Fortune 500, with worldwide revenues of $16.8 billion last year. But “this is just the start. We have big plans to grow,” says Yang Yuanqing, Lenovo’s chairman. One reason why his company could afford to buy a piece of Big Blue was its leading position in a domestic market buoyed by GDP growth rates that dwarf those in developed countries. These are lifting the incomes of millions of people to a level where they start to splash out on everything from new homes to cars to computers. “It took 25 years for the PC to get to the first billion consumers; the next billion should take seven years,” says Bill Amelio, Lenovo’s chief executive.



Largest Mergers Acquired Company Value / Price Acquirer Year

Note: This list contains buyouts, mergers, acquisitions and partial buyouts of company assets.

Mannesmann $202,800,000,000 Vodafone 1999

Time Warner $164,700,000,000 America Online AOL 2000

Philip Morris International $107,600,000,000 Shareholders 2008

ABN-AMRO $98,500,000,000 RBS 2007 Pharmacia Corporation $89,200,000,000 Pfizer 2003 Warner-Lambert Co. $88,800,000,000 Pfizer 2000 Mobil Corp $85,100,000,000 Exxon Corp 1999 SmithKline Beecham $76,000,000,000 Glaxo Wellcome 2000 Suez $75,200,000,000 Gaz de France 2008

Shell Transport & Trading Company $74,600,000,000 Royal Dutch Petroleum 2004

BellSouth Corporation $72,700,000,000 AT&T 2006 AT&T Broadband $72,000,000,000 Comcast Corp 2002 Citicorp $72,600,000,000 Travelers Group 1998 Aventis $65,600,000,000 Sanofi-Synthelabo 1999 Bank America Corp $64,000,000,000 NationsBank 1998 Kraft Foods Inc $61,600,000,000 Shareholders 2007 GM Certain Assets $61,200,000,000 U.S. Treasury Dept 2009 Bank One $58,000,000,000 JP Morgan 2005 Gillette Co. $57,000,000,000 Procter & Gamble 2005 US West $56,400,000,000 Qwest 2000 GTE $53,000,000,000 Bell Atlantic 1999 Tele-Communications Inc $48,000,000,000 AT&T 1998 Energy Future Holdings $44,370,000,000 KKR, TPG, Goldman Sachs 2007 Ameritech $42,000,000,000 SBC 1999 Alcon $39,000,000,000 Novartis 2008 Equity Office Properties $38,900,000,000 Blackstone 2007 Medco Health Solutions Inc. $34,300,000,000 Express Scripts, Inc. 2011 Hospital Corp. of America $32,700,000,000 Bain, KKR, Merrill Lynch 2006 RJR Nabisco $31,100,000,000 KKR 1989 First Data $29,000,000,000 KKR, TPG 2007 Harrah’s Entertainment $27,400,000,000 Apollo Global Management, TPG 2006 Alltel $27,000,000,000 Goldman Sachs, TPG Capital 2007 Clear Channel $25,700,000,000 KKR, Bain Capital, Thomas H. Lee 2006 Hilton Hotels $26,000,000,000 Blackstone 2007 Alliance Boots $24,800,000,000 KKR 2007 Kinder Morgan $21,600,000,000 Carlyle, Goldman Sachs and Riverstone 2006 Synthes $21,300,000,000 Johnson & Johnson 2011 Freescale Semiconductor $17,600,000,000 Blackstone, Carlyle, Permira and TPG 2006 Albertson’s $17,400,000,000 Cerberus Capital Management 2006 Capmark $16,700,000,000 KKR 2005



Hertz $15,000,000,000 Carlyle, Merrill Lynch and Clayton Dubilier & Rice 2005

Petrohawk Energy Corporation $14,900,000,000 BHP Billiton Limited 2011 Lycos $12,500,000,000 Terra Networks 2000 Kelda Group PLC $10,600,000,000 Citigroup Inc, HSBC Holdings PLC 2007 PeopleSoft $10,300,000,000 Oracle 2004 Centro Properties Group $9,000,000,000 Blackstone 2011 Millennium Pharmaceutical $8,800,000,000 Takeda Pharmaceutical 2008 Skype $8,500,000,000 Microsoft 2011 Massey Energy $8,280,000,000 Alpha Natural Resources, Inc. 2011 Navteq $8,100,000,000 Nokia 2008 Excite $6,700,000,000 @Home 1999 aQuantive $6,000,000,000 Microsoft 2007 Broadcast.com $5,700,000,000 Yahoo! 1999 Kinetic Concepts Inc $5,000,000,000 Apax Partners 2011 Ranbaxy $4,600,000,000 Daiichi Sankyo 2008 Netscape $4,200,000,000 AOL 1998

GeoCities $3,560,000,000 Yahoo! 1999

Weather Channel $3,500,000,000 Bain, Blackstone, NBC Universal 2008 WebEx $3,200,000,000 Cisco Systems 2007 DoubleClick $3,100,000,000 Google 2008 Skype $2,600,000,000 EBay 2005 Isis Pharmaceutical $1,900,000,000 Genzyme 2008 YouTube $1,650,000,000 Google 2006 Overture $1,600,000,000 Yahoo! 2003 Ask Jeeves $1,850,000,000 IAC/Interactive Corp 2005 PayPal $1,500,000,000 eBay 2002 Zappos $1,200,000,000 Amazon 2009 Fast Search & Transfer $1,200,000,000 Microsoft 2008 Mapquest $1,100,000,000 AOL 1999 Instagram $1,000,000,000 Facebook 2012 ATG $1,000,000,000 Oracle 2010


Source: http://www.statisticbrain.com/largest-corporate-buyouts-mergers-and-aquisitions/ (source: Reuters, BBC, Wall Street Journal, Forbes, MSNBC)

http://www.statisticbrain.com/largest-corporate-buyouts-mergers-and-aquisitions/


The rise of the superbrands

Legal Aspects U. S.’s Justice Department versus Microsoft. EU versus General Electric + Honeywell



Example – Utility Mergers in the US

John R. Becker-Blease, Lawrence G. Goldberg, Fred R. Kaen Mergers and Acquisitions as a response to the deregulation of the electric power industry: value creation or value destruction? J. of Reg. Econ. 33, 21-53, 2008.





Cumulative Abmormal Returns Three Days before the Merger

Returns deal to close (11 – 950 days)




Post completion performance


Austrian power industry since liberalization


Land Versorgungsgebiet Eigentümer

Umsatz in 1996

Milliarden S EVN Niederösterr. 51 % Land Niederösterreich;

49 % Aktien 7,7

BEWAG Burgenland 51 % Land Burgenland; 49 % Burgenland Holding 1,8

KELAG Kärnten 64 % Land Kärnten; 35 % Verbund; 1 % Angestellte

4,2

SAFE Land Salzburg 64 % Land Salzburg; 36 % OKA 3,9

Salzburger Stadtwerke Stadt Salzburg 51 % Stadt Salzburg;

49 % SAFE 3,9

Wienstrom Wien 100 % Land Wien 12,5 TIWAG Tirol 100 % Land Tirol 5,9

VKW Vorarlberg 76,4 % Land Vorarlberg; 20,4 % privat; 3,2 % Gemeinden

2,6

STEWEAG Steiermark 75 % Land Steiermark; 25 % EdF 6,2

Owners (private ones in italics) of Austrian utilities Landesgesellschaften (revenues from electricity).


Austrian power industry since liberalization



Mergers and the European Union


American businessmen have regarded Mario Monti as the corporate equivalent of Saddam Hussein ever since he dared last year to block Jack Welch's audacious


Breaking up companies is back in fashion

FOR weeks, speculation has been rife that Pfizer, the world’s biggest pharmaceuticals company, will break itself into pieces, a restructuring move known as the starburst. So far this year, firms on the world’s stockmarkets have spun off bits of themselves as separate listed companies worth a total of $92 billion, Citigroup calculates. That compares with $54 billion in all of last year, and if the current rate continues, it will easily beat the pre-crisis record of $234 billion in 2007. So far this year the biggest such deal has been Fiat’s spin-off of a division that makes lorries and tractors, valued at $18 billion. This is still overshadowed by the largest on record, Altria’s $108 billion spin-off in 2008 of its Philip Morris International cigarette business. America’s largest deal this year is Motorola’s hiving-off of its handset-making business, worth $10 billion. ITT, a serial starburster, recently separated off its defence and information business, and a water company, leaving behind a smallish engineering group.




The trend is catching on around the world: Carlos Slim, a canny Mexican billionaire, is spinning off Minera Frisco, the mining arm of his Carso conglomerate, worth $7 billion. One of the main reasons for the starburst revival is that companies seeking buyers for parts of their business are not getting good offers from other firms, or from private equity. Foster’s, an Australian drinks group, is prepared to sell its wine business but, if no decent offer is forthcoming by May, will spin it off. Another driving force is the “conglomerate discount”—when stockmarkets value a diversified group at less than the sum of its parts. By comparing conglomerates’ constituent businesses with similar, stand-alone ones, Mr Stendevad calculates that they now trade at a discount of around 9%—more or less where things stood before the crisis of 2008. There is talk that Lufthansa, which Citigroup reckons would in pieces be worth twice the parent company’s market value, may spin off its in-flight catering business. Although the conglomerate discount is not usually as extreme as that, its sharp increase in the past year is one of the main reasons companies are regaining their enthusiasm for spin-offs, says Carsten Stendevad of Citigroup.




The conglomerate discount is far bigger in America and Western Europe than in Asian and emerging economies. This may be because in these countries a big conglomerate with political connections and an understanding of how to operate in a difficult market can spread its expertise across many industries. Indeed, there is a conglomerate premium of 10.9% in Latin America, according to Citigroup. This may be why, in some parts of the world, conglomerates are becoming even more diversified: witness Samsung Electronics, which is moving into pharmaceuticals. America’s big tech firms are also bucking the starburst trend and diversifying. Oracle, a software giant, has moved into hardware, and Hewlett-Packard, a computer-maker, is expanding further into software and services. Their big corporate customers increasingly want a one-stop shop for their information systems. Even so, this year’s surge in spin-offs and the rise in the conglomerate discount certainly suggest that new diversifications are likely to be far outweighed by corporate break-ups. Until, that is, management gurus and investment bankers cook up a new theory to justify conglomerates, and the cycle of integration and disintegration starts all over again.



Keeping it under your hat The Economist, April 16th, 2016


APPLE and Tesla are two of the world’s most talked-about companies. They are also two of the most vertically integrated. Apple not only writes much of its own software, but designs its own chips and runs its own shops. Tesla makes 80% of its electric cars and sells them directly to its customers. It is also constructing a network of service stations and building the world’s biggest battery factory, in the Nevada desert. A century ago this sort of vertical integration was the rule: companies integrated “backwards”, by buying sources for raw materials and suppliers, and “forwards”, by buying distributors. Standard Oil owned delivery wagons and refineries in addition to oil wells. Carnegie owned iron-ore deposits and rail carriages as well as blast furnaces. In his 1926 book “Today and Tomorrow” Henry Ford wrote that vertical integration was the key to his success: “If you want it done right, do it yourself.” He claimed he could extract ore in Minnesota from his own mines, ship it to his River Rouge facility in Detroit and have it sitting as a Model T in a Chicago driveway—in no more than 84 hours.




Today this sort of bundling is rare: for the past 30 years firms have been focusing on their core business and contracting out everything else to specialists. As markets became more sophisticated these justifications fell away. Thanks to globalisation, companies could always find new resources and better suppliers. Reasons for the reversal abound, but five stand out. • The most important is simplicity. Consumers to press a button and let the machine do the rest. This is

largely why Apple opted for integration. • Firms operating on the technological frontier often find it more efficient to do things in-house. Companies

that are inventing the future frequently have no choice but to pour money into new ventures rather than buy components off the shelf. This explains Tesla’s “gigafactory” for batteries.

• Choice: The more the market has to offer, the more important it is to build a relationship with customers. Netflix and Amazon now create their own television shows in order to keep their viewers from buying more generic content elsewhere.

• Choice is reenforced by speed: Spain’s Zara have resisted contracting out everything. Instead, they operate their own clothes factories, employ their own designers and run their own shops. This gives them a big advantage: they can turn the latest trend into new product, often in small batches, and have it in stores in a couple of weeks. Less vertically integrated brands such as Gap and American Apparel find they are stuck with yesterday’s creations because they cannot get supply chains to produce new wares quickly.




• And then there is a combination of old worries about geopolitical uncertainty and new worries about the environment. In 2014 Ferrero, an Italian confectionary-maker, bought Oltan Gida, which produces one-third of Turkey’s hazelnuts, the vital ingredient in Nutella. In 2015 IKEA, a Swedish furniture company, bought nearly 100,000 acres of forests in Romania and the Baltic region. Earlier this year ChemChina, a state-owned company, purchased Syngenta, a Swiss seeds and pesticides group, for $43 billion, driven by the government’s quest for food security. Cruise companies such as Costa Cruises and Disney have bought islands in the Caribbean and the Bahamas so that they can guarantee that their passengers will have somewhere empty and unspoiled to visit when they sail past.


New merger wave

However most recently signs of another merger wave (because some companies are awash with cash). Shall We? The Economist, Feb. 9th, 2013, p 57 Recently, US Airways & American Airlines (under ch. 11).



The more general questions: Existence and Limit of Firms- Make or Buy

Hart (2008), “In his 1937 article, Coase first raised the question of why we have firms at all in a modern market economy. If, as economists usually suggest, markets are so good at allocating resources, why do we need firms? Coase recognized that the converse question also has to be answered. Firms cannot always be better at allocating resources, since if they were we would not have markets. In D. H. Robertson’s words, we find ‘islands of conscious power in this ocean of unconscious co-operation like lumps of butter coagulating in a pail of buttermilk’ ” 1. In February 2007 there were 41 companies in the world with a market value of

equity greater than US $100 billion 2. In 2007 Wal-Mart, the largest US employer, had 1.8 million employees. 3. The value of transactions in US firms is approximately equal to that in US

markets.



The more general questions: Existence and Limit of Firms- Make or Buy

4. As Table 1 shows, the employee-weighted average size of firms that is, the average number of employees in the same firm as a randomly selected employee is sizeable, ranging from 296 to 935 in different countries in 1988 and 2001.

5. In a sample of 43 countries, two-thirds of the growth in industries over the 1980s came from growth in the size of existing firms.

6. The boundaries of firms keep changing. In 2006 the world-wide value of mergers and acquisitions exceeded US $4 trillion.



Approaches to integration & make or buy

Neoclassical Economics (U-shaped cost curve)

Transaction Costs Two Approaches on integration in detail: 1. Private information about integration gain.

2. Theory of property rights (we follow here Oliver Hart (1995); see also

Alchian, Demsetz).



Neoclassical U-shaped cost function


marginal costs

Average costs

Average costs two firms

quantity

Average costs

€

One firm or two firms are efficient


Transaction Cost Economics (Coase, Williamson) = Costs associated with Contracts (i.e. with market operations)

Contracts are revised and renegotiated all the time due to hard to think far ahead difficult to negotiate about these future terms difficulties in writing down such contracts such that they are enforceable by court In short due to bounded rationality Therefore, contracts are renegotiated as future unfolds. Why worry? Because of 1. haggling 2. inefficiency due to asymmetric information (compare inefficiency theorem of above) This relates crucially to relation specific investments, since these costs are small if switching is easy. How would these costs change with merging? Vague implication of TC-approach. In particular, why is opportunism eroded by an integration? Internal ‘courts’ and sanctions; commands - ‘fiat’.



Vertical Integration

The actual or potential gain from integration is only known to the manager i.e., the manager’s private information



Vertical Integration

Result: Separation versus Integration



Summary

Costs – separate units: C = (a + b). Agent (integrated) – Costs: C = (a + b)t, t [0,1] Principal: V = pD(p) W = - (a + b)tD(p) h = -f/F => [pD’ + D] - (a + b)tD’ = (a + b)D’F/f. Cut off point for disintegration: = 1


[ ]∫−

+−−+−=t

pDbaptFdttftstpDtpt

mm

ttp

0

0

)()())(1()()]())(()([max 0}),({π

( )( )

notor integrated if and 1

babafFt

Cp

Cp+

++==

−ε

)()(

0

00 tf

tFt +

t

t 1t0

(a + b)t

a + b

[t + F(t)/f(t)](a + b)

$


Theory of Property Rights – Oliver Hart

Model and Assumptions: 1. incomplete contracts 2. complete information 3. Equal division of integration gain Nash cooperation, or Rubinstein (non-cooperative) bargaining – Gibbons proof.



Hold-Up-Problem.

Example: Danger: Appropriation of the quasi-rent by the buyer.



Theory of Property Rights

Theory of Property-Rights was initiated by Demsetz and Alchian. Oliver Hart (1995) is the most prominent and comprehensive account of this approach. It is the owner of the property rights that can fill any gap in the contract. Example: Renting versus owning a car (or a flat). Cooperation, first best outcome, requires the participation of both

managements M1 and M2. Merger, integrations and takeovers ensure only the transfer of physical capital

(therefore property - rights – approach), but not of the management and the human capital of the acquired enterprise.

Therefore it is assumed that any takeover looses the cooperation of the management that itself looses the control over the equipment due to the takeover.

Beyond shareholder value (The Economist, Jun 26th 2003)



Model: Possible forms of integrating

0 no integration, M1 owns a1, M2 owns a2. 1 M1 owns {a1, a2}, M2 owns ∅ 2 M2 owns {a1, a2}, M1 owns ∅ A Property right of M1, {a1, a2}, {a1}, ∅ B Property of M2, {a1, a2}, {a2}, ∅ i investment of buyer e seller’s effort R(i) revenues (cooperation, trade) C(e) costs (of effort) r(i, A) revenues without trade contingent on property right c(e, B) costs, also contingent on property right Assumptions: R(i) – C(e) > r(i, A) – c(e, B) for all i, A, B R´(i) > r´(i, {a1, a2}) ≥ r´(i, {a1}) ≥ r´(i, ∅) |C`(e)| > |c´(e, {a1, a2})| ≥ |c´(e, {a2})| ≥ |c´(e, ∅)|



Timing


Firms 1 & 2invest

surplus from cooperation is shared 50-50

Each firm exercises ist outside option

timeEx ante Ex post

NoncooperativeNash

not verifiable(but observable)

yes in equilibrium

cooperation

noFirms 1 & 2

investsurplus from cooperation is

shared 50-50

Each firm exercises ist outside option

timeEx ante Ex post

NoncooperativeNash

not verifiable(but observable)

yes in equilibrium

cooperation

no



First Best R (i) – C(e) – i – e max R´ = 1 (i*,e*) C´ = -1


Marginal Benefit of M1: Increase in revenues due to investing $1, i = 1.

Marginal Benefit of M2: Reduction of costs due to investing $1, e = 1.

First best solution (i*, e*) is not implementable in a world with incomplete contracts, since The first best solution supposes cooperation

and participation of both managements M1 und M2.

However, acquisition of a company is restricted to property rights, thus the naming, of the (physical) equipment but not of the human capital (in particular of the management) of the firm.

Hence, it is assumed that the human capital and the cooperation of the managers of the acquired company gets lossed.



Second Best Solution Assumption: non-contractible ex-ante investments i and e determines threat point from which ex-post cooperation (following Nash’s bargaining solution) splits the additional surplus due to trade. That is, we must determine following the above logic p selling price π1 = R – p = (r - ) + ½ [(R – C) – (r – c)] Cooperation gain profit no cooperation ( spot price)

R – r + - ½R + ½C - ½r - ½c = p p = + ½(R – r) – ½(c – C)

Buyer: π1 = R – p = R – [ + ½(R – r) – ½(c – C)] = - + ½(R + r) + ½(c – C)


p

p

p p

p p



π2 = p – C = [ + ½ (R – r) – ½ (c – C)] - C π2 = - ½ (C + c) + ½ (R – r)


p

p


Possible forms of integrating Buyer’s investment (i) owning A

Buyer owning A has the following gain if investing i π1 – i = - + ½R(i) + ½ r(i, A) - ½C(e) + ½c(e, B) – i FOC for optimal i: ½R´+ ½ r´(i,A) – 1 = 0 ½(R´(i) + r´(i,A)) = 1 and recall R´ > r´(i, A) for all i, A


p


Possible forms of integrating Buyer’s investment (i) owning A

Buyer owning A has the following gain if investing i π1 – i = - + ½R(i) + ½ r(i, A) - ½C(e) + ½c(e, B) – i FOC for optimal i: ½R´+ ½ r´(i,A) – 1 = 0 ½(R´(i) + r´(i,A)) = 1 and recall R´ > r´(i,A) for all i, A


p

½(R´+r´(i,{a1,a2})

½(R´+r´(i,{a1})

1

½(R´+r´(i,0) R´(i)

i

i2 i0 i1 i*

Therefore: i* > i1 ≥ i0 ≥ i2


Possible forms of integrating Seller’s investment (e) owning B

Seller owns B and maximizes π2 – e = - ½ (C(e)+ c(e, B)) + ½ (R(i) – r(i, A)) – e FOC for optimal e: - ½(C´+ c´(e,B)) –1 = 0 ½|C´| + ½|(c´(e,B)| = 1 and recall |C´| > |(c´(e,B)| for all e, B


p


Possible forms of integrating Seller’s investment (e)

Seller owns B and maximizes π2 – e = - ½ (C(e)+ c(e, B)) + ½ (R(i) – r(i, A)) – e FOC for optimal e: ½(C´+ c´(e,B)) –1 = 0

½|C´| + ½|(c´(e,B)| = 1


p

e1 e0 e2 e*

e

-1

½(C´+c´(e,{a2})

½(C´-c´(e,0))

½(C´+c´(e,{a1,a2}) C´(e)

Therefore: e* > e2 ≥ e0 ≥ e1


Summary – second best analysis

Recall: i* > i1 ≥ i0 ≥ i2 e* > e2 ≥ e0 ≥ e1 Total surplus: S = R(i) – C(e) – i – e No integration (0) S0 = R(i0) – C(e0) – i0 – e0 Integration (1) S1 = R(i1) – C(e1) – i1 – e1 Integration (2) S2 = R(i2) – C(e2) – i2 – e2 It is optimal to choose that integration that maximizes surplus S. And capital markets may enforce that.



Implications:

No specific investment => integration is always sub-optimal Firms lacking any kind of synergy should be have different owners.

Thus, Conglomerates should be inefficient. Reason: useful control rights are destroyed.

Firms should own assets requiring sensitive investment decisions Examples: car, home.

No property rights to parties insensitive to investment decision. Hence, no property rights and entitlements to lower rank staff.

Sufficiently complementary assets should be owned by one Examples: Joskow.

Flexibility lowers need for integration Finance: Debts discipline managers (versus Modigliani – Miller)



Application: Public Private Partnerships

Hot issue, Examples (Nordautobahn, U.K. – Blair’s Third Way), Bad Banks Prisons WHEN Britain stopped dispatching convicts to its American colonies in 1775, it had to find some other way of dealing with miscreants. So it arranged to have them put away in ships which never left London; convicts were simply locked up in vessels moored on the Thames, whose owners were paid for the service. A few years later, a new penal colony in Australia eased the strain; and prisons shifted firmly back to state control, at least where states existed, for the next two centuries More than 17% of Australia's inmates are held in private prisons, says Stephen Nathan, the editor of Prison Privatisation Report International. Next comes Britain, with 10%, and America at 7%. These markets are dominated by big prison-services firms such as GEO, MTC and Serco, which claim that private jails are better, cheaper and more accountable in both construction and management.

Road Runners: The popularity of infrastructure investing, The Economist, January 20th, 2007, p 79. WHEN the Pennsylvania turnpike opened on October 1st 1940, motorists queued for hours to travel on what was called “America's first superhighway”. Now investors are waiting in line for the toll road, which may become the next bit of American infrastructure to be privatised. Forty-eight firms expressed an interest in leasing the road, after Governor Ed Rendell floated the idea. Unusually, America is catching up with a trend that was pioneered elsewhere—in this case as far away as Australia. Infrastructure has become the most fashionable of asset classes, as governments desperate for cash link up with pension funds desperate to diversify out of shares and bonds. Some big deals have already been done: Indiana got $3.9 billion for a 75-year road lease last June, and Chicago earned $1.8 billion for the 99-year lease of its skyway, which runs for less than eight miles (13km). Investors are just as eager to buy whole companies as they are to back single projects: witness the £10.3 billion ($19.2 billion) takeover by Ferrovial, a Spanish construction firm, of BAA, which runs Britain's biggest airports, and the £8 billion purchase of Thames Water, a British utility, by Macquarie, an Australian investment bank. But this frenzy of activity is causing some alarm. Michael Wilkins of Standard & Poor's, a rating agency, gave warning last year: “The infrastructure sector is in danger of suffering from the dual curse of overvaluation and excessive leverage—the classic symptoms of an asset bubble.” He estimated that $100 billion-150 billion of capital was raised last year to invest in infrastructure. As money pours into the industry, prices are going up and future returns are being revised down.



Application: Public Private Partnerships

Why are investors so keen? Part of the reason is that pension funds have changed their behaviour, to seek out assets that match their liabilities. Infrastructure assets look ideal, because they are long-term with revenues that tend to be linked to inflation. Because deals are made with governments, they look safe. They also supply an income. The pension fund of John Lewis Partnership, a British retailer, invested £25m in an infrastructure fund last year. Its investment manager, Andrew Chapman, said, “We see infrastructure as somewhere between equities and bonds: some growth prospects and a very good running yield.” Infrastructure assets have also attracted private-equity groups. “They like the predictable cashflows, the limited competition, high barriers to entry and regulatory protection,” says Mr Wilkins. But that creates another doubt. The model championed by Macquarie, one of the leaders in the field, is to treat infrastructure as a 25- to 30-year investment. That, claims Macquarie, gives it an incentive to undertake capital expenditure, since it has a prospect of earning a decent return over the long term. Private-equity groups do not look that far ahead. “They are looking for a three- to five-year holding period, at most,” says Mr Wilkins. That makes capital-expenditure programmes look unattractive. In the short term, the surge of money does seem to be making deals look riskier. Moody's, another rating agency, says that the average rating of toll-road debt has declined by five grades since 2001. But perhaps the surge of investor demand will be counteracted by a wave of supply from governments. The idea of privatising is probably most deeply embedded in Britain and Australia. The growing acceptance of the concept in America is opening a huge new market. And Merrill Lynch projects that infrastructure spending in emerging markets could exceed $1 trillion in the next three years—$400 billion in China, $110 billion in India, $185 billion in Russia and $150 billion in the Middle East. The trouble is that investing in Britain, America and Australia, where regulatory regimes are clear and predictable, may prove easier than venturing into some developing countries. Subsidiaries of Suez, a French utility group, eventually lost water contracts in Argentina and Bolivia after facing stormy political opposition to tariff increases. Venezuela is planning to nationalise its biggest electricity group, now majority-owned by AES, an American power company. Furthermore, the trade-off between the risks and rewards of investing in utilities can be skewed. As investors in Britain have found, high returns in one period cause the regulator to adjust his calculations for the next, so that the upside is capped whereas the downside is not. Even in the rich world, infrastructure assets can come unstuck. Take a transport project blessed with a 55-year lease (at the outset) and a service that slashed the travel time between two historic capital cities, much loved by tourists. Does that sound like a sure-fire investment? Alas, the proprietor, Eurotunnel, filed last year for the French equivalent of Chapter 11.

And Others: Hospitals Schools, etc.



Public Private Partnerships Oliver Hart, Economic Journal 2003.

About publicly provided goods (schools, prisons, hospitals). Good investment (i), i.e. quality. Bad investment (e), i.e. cost cuts by saving on quality, hence e* = 0 is socially optimal Timing (two periods, first build and then run, e.g. a school, hospital, prison, etc.) Benefits B = B0 + (i) – b(e) Cost of Service C = C0 - (i) – c(e) First Best: max B – C – i – e = [B0 + β(i) – b(e)] – [C0 – γ(i) – c(e)] – i – e => β’(i*) + γ’(i*) = 1, but corner solution for bad investment, e* = 0. | Prof. Wirl SS 2016

γ

β



Separate Contracts (e.g. one building, one for running a hospital) t = 0: P0 price for building. Max P0 – i – e => Joint Contracts (for building and running a hospital) Max P0 – C - i – e = = P - [C0 – γ(i) – c(e)] – i – e. => γ’(i) = 1 and c’(e) = 1 i.e., underinvestment of good (i) and overinvestment of bad (e).



Separate Contracts Joint Contracts: γ’(i) = 1 and c’(e) = 1 (identified by ~) First Best : β’(i*) + γ’(i*) = 1 and e* = 0.



1

0* ==∧

ee~e

c‘

e

1

0=∧

i~i *i

'γ'γβ +

i

1

0* ==∧

ee~e

c‘

e

11

0* ==∧

ee~e

c‘

e

1

0=∧

i~i *i

'γ'γβ +

i

1

0=∧

i~i *i

'γ'γβ +

i


Implications

If it is possible to write good contracts for construction (e.g. schools, prisons), then separate contracts are advisable, because that eliminates the bad investment and, by assumption, the good investment can be written into the contract.

If it is possible to write service contracts, then joint contracts are preferable (e,g, for hospitals).

Nonsense (but practice): finance.



Extension: Contracts as Reference Points Hart (2008), Hart and Moore (2010)

Objective: Instead of (Coasean) bargaining account for haggling costs. A seller (S) can provide a good that costs 10 and is worth 20 to a buyer (B). To fix ideas, assume that B is arranging a musical evening at which B wants S to sing songs. The musical performance is worth 20 to B, and S’s cost of performing (an effort cost, say) is 10. Nash/Coase solution is p = 15. However B and S have some discretion about the ‘quality’ of performance. loosely speaking: if S feels payed too little she will sing unenthusiastic, if B feels that he has payed too much he will treat S unfriendly Timeline Contracting at date 1: S thinks she is entitled to get 20, B thinks he should only pay 10. Then the contract price p = 15 lets both feel aggrieved => both will provide for poor performance (each party shades 5 where scales the degree of shading) and surplus falls to 10(1 – )


θ θ θ


Assumptions: musical evening

Not all the details can be anticipated at date 0. The musical evening can be carried out according to two different methods. (the methods

e.g. differ in the songs/composers performed or the order of the program, etc.) The methods cannot be specified in the date 0 contract, because they are too

complicated to describe in advance. e.g. B doesn´t know which of his friends will come to the musical evening, and

therefore doesn´t know at t=0 which type of music the audience prefers However, the choice between them becomes clear at date 1. (at the date of the musical

evening he knows which friends actually show up and he knows their preferences)

Questions: which method is choosen? and which implications has this choice on the surplus?



Example - musical evening Case 1

Organization 1: S is independent contractor for price fixed at t = 0 at p = 10. (S chooses task) Organization 2: S is employee hired at t = 0 at p = 10. (B chooses task) Outcomes: Organization 1: B and S fix the price of the good at date 0 (at 10, say) and determine that S will be an independent contractor. Thus S has the right to decide on the details of production, i.e. between methods 1 and 2. Given that the price is fixed, S will pick method 2, since it is cheaper. This is inefficient. B will then be aggrieved that S didn’t choose 1. B (looses 6 units) will shade to the point where S’s payoff falls by 6q. Total surplus = 6 – 6q Organization 2: S is an employee and will work for B at a fixed wage (10, say). Therefore, B has the right to decide on the method and will of course choose 1. Hence, S will be aggrieved but S’s aggrievement is only 2. Total surplus = 10–2q. Therefore Organization 2 is efficient: The parties would agree on method 1: there are 10 dollars of surplus to argue over, shading costs equal 10q: net surplus = 10(1– q), which is less than that obtained under the employment contract.


=> Method 1 is efficient


Example - musical evening Case 2


Organization 1: S is independent contractor (S chooses) Organization 2: S is employee hired at t = 0. (B chooses) Under employment, the buyer will choose method 1, yielding surplus 10–8s. Independent contracting is superior here because the seller will select method 2, yielding surplus 12–6s. We see that employment is good if the production method matters more to B than to S, while independent contracting is good if the production method matters more to S than to B. Unconstrained bargaining is inefficient! Efficient method, but high aggrievement costs. In Case 1 the parties would agree on method 1: there are 10 dollars of surplus to argue over, shading costs equal 10s: net surplus = 10(1 – s), which is less than that obtained under the employment contract. In Case 2 there are 12 dollars of surplus to argue over and net surplus = 12(1 – s) is less than that obtained under independent contracting.

We see that employment is good if the production method matters more to B than to S, while independent contracting is good if the production method matters more to S than to B.


Implications

The model suggests that outsourcing is likely to be efficient when a detailed contract can be written about the nature of the good to be delivered, since in this case B’s value will be pretty insensitive to the choice of production method while S’s cost may not be (see Figure 3).

In contrast, if a detailed contract is hard to write and B’s value is very sensitive to the details of production, then in-house production may be better.



The Agency Problem and Incentives

Alternatives to integrating Holmström and Roberts

Journal of Economic Perspectives, 1998.

Many industries have established alternatives to integration in order cope with the hold-up problem. Examples: Japanese automobile industry and its relation to its suppliers contrast the (at least formerly) fully

integrated American and European pendent. NUCOR steel mills that sub-contract all its scrap comes from a single company: J. Joseph Company. Airline Alliances but ‘dark’ side Volvo – Renault. Network companies – NIKE, Benetton Microsoft, Intel are separate despite substantial synergies between software development and chip

design Puzzle? Supermarkets versus Restaurants Complementarity (Supermodularity): Lincoln Electric Company – not capable of copying its own

model!



Further Aspects of Takeovers

Eliminating and disciplining efficient managers Debts as signal for an efficient (i.e. not interested in empires and

luxury) management (Hart und Moore). David Landes in The Wealth and Poverty of Nations about the decline

of the British automobile industry, “Never underestimate the leisure preference of bosses, any more than of workers.”



Empirical Findings and Case Studies

FRANCINE LAFONTAINE AND MARGARET SLADE Vertical Integration and Firm Boundaries: The Evidence, JEL XLV, 629-685, 2007.


THE CONSEQUENCES OF VERTICAL INTEGRATION Author Year Industry Data/Technique

Variable Examined (y) Effect Effect on y on W

Shelton 1967 Restaurant Panel; Costs + + Description Profit + Levin 1981 Crude oil and

refining Panel; Regressions Profit Stability of

profit −∗ − +

McBridea 1983 Cement and concrete

Regional panel; Regressions

Delivered price −∗ +

Spiller 1985 Various Cross section; Regressions

Financial gains Systematic risk

+∗ − +

Helfat and Teece

1987 Various Paired samples; Difference in difference

Systematic risk −∗ +

Anderson 1988 Electronic component sales

Cross section; Regressions

Index of opportunism −∗ +

Kerkvliet 1991 Coal and electricity

Panel; Regressions Cost efficiency Exercise of monopsony power

+∗ −∗

+

Muris, 1992 Soft drinks Panel; Regressions Retail price −∗ + Scheffman, and bottlers and Spiller Shepardb 1993 Gasoline

refining and sales

Cross section; Regressions Retail price −∗ +

Ford and Jackson

1997 Cable TV programming and distribution

Cross section; Regressions Program cost Price −∗ +∗

?

Edwards, 2000 Crude oil and Panel; Ordered probit Stock rating +∗ ?

Jackson, and refining and Thompson pipelines Corts 2001 Film

production and distribution

Cross section; Tobit Release date clustering −∗ +

Mullainathan 2001 Chemical Panel; Regressions Investment −∗ ? and Scharfstein

responsiveness

Ciliberto 2005 Physicians and Panel; Regressions Investment in health +∗ + hospitals care services Jin and Leslie 2005 Restaurant

chains Panel; Regressions Quality (health scores) +∗ +

Gil 2006 Movie distribution

Cross section; OLS, Duration Analysis

Movie run length +∗ +

∗ denotes significance at 5 percent using a two-tailed test. a Johnson and Parkman (1987) note that the introduction of time trends in the regressions renders effects

documented here insignificant.b results significant for unleaded sold full service only.


Summary LAFONTAINE AND SLADE (2007).

Agency Model: “Two central predictions of the moral-hazard model of forward integration have been confirmed by the empirical evidence. These are that as the importance of local or downstream effort grows, integration becomes less likely, whereas as the importance of companywide or upstream effort grows, integration becomes more likely, where importance is measured by the marginal productivity of effort. Moreover, the idea that monitoring the agent is costly is also central to the moral-hazard model of contracting. Nevertheless, there has been some confusion in the literature concerning the effect of higher monitoring cost on vertical integration. We showed that once one recognizes that there are two sorts of monitoring that the principal can perform—outcome and behavior monitoring—the evidence again is highly supportive of the agency model. On all these fronts, the moral-hazard model performs very well.”




Transaction costs: “The weight of the evidence is overwhelming. Indeed, virtually all predictions from transaction-cost analysis appear to be borne out by the data. In particular, when the relationship that is assessed involves backward integration between a manufacturer and her suppliers, there are almost no statistically significant results that contradict TC predictions.”




Although property-rights models have been around for two decades, empirical testing of predictions derived from those models lags behind. Nevertheless, as argued above, we can glean some insights into the validity of PR theories through a reinterpretation of tests of MH and TC predictions. In particular, the evidence that comes from supplier–manufacturer relationships, which is the typical setting of TC tests, is not very supportive of PR arguments, at least when the two sets of predictions disagree. However, the evidence that comes from manufacturer–retailer or franchisor–franchisee relationships is much more positive. Not only is it consistent with many PR predictions, but also PR ideas provide insights into and suggest a solution to a puzzle that surfaces in the MH literature, namely the negative relationship between risk at the retail level and vertical integration. Still, much further work is needed before the relative lack of direct tests of PR predictions can be adequately addressed, and, perhaps more importantly, the potential for cross fertilization among tests of different models can be fully realized.



Sanghooh Ahn, Firm Dynamics and Productivity Growth: A review of Micro Evidence from OECD Countries, OECD, ECO/WKP (2001)23, 2001.

Reviews sources of growth Productivity growth within firms Reallocation – expansion & contraction Entry exit



Other Cases

Gesamteffizienz technische Effizienz größenabh. Effizienz

Ost West Verhält Ost West Verhäl. Ost West Verhält Produktionstyp

Getreide 0,78 0,83 0,94** 0,93 0,93 1,00*** 0,84 0,89 0,94** Vieh 0,81 0,87 0,93*** 0,87 0,95 0,92*** 0,93 0,92 1,01*** Schweine,

Geflügel

0,94 0,86 1,09** 0,97 0,97 1,00* 0,97 0,89 1,09**

Gemischt 0,85 0,87 (0,98) 0,97 0,91 1,07*** 0,88 0,96 0,92** Rechtsform Einzeluntern. 0,79 0,85 0,93*** 0,90 0,94 0,96*** 0,88 0,90 0,98** Personeng. 0,88 0,92 (0,96) 0,92 0,94 (0,98) 0,96 0,98 0,98* Kapitalges. 0,81 0,95 0,85 Genossen. 0,76 0,98 0,78


Efficiency German Agriculture (former FRG versus former GDR)


Other Cases

Land

Versorgungsgebiet Eigentümer

Umsatz in 1996

Milliarden S

EVN Niederösterr.

51 % Land Niederösterreich; 49 % Aktien 7,7

BEWAG Burgenland 51 % Land Burgenland; 49 % Burgenland Holding 1,8

KELAG Kärnten 64 % Land Kärnten; 35 % Verbund; 1 % Angestellte

4,2

SAFE Land Salzburg

64 % Land Salzburg; 36 % OKA 3,9

Salzburger Stadtwerke

Stadt Salzburg

51 % Stadt Salzburg; 49 % SAFE 3,9

Wienstrom Wien 100 % Land Wien 12,5 TIWAG Tirol 100 % Land Tirol 5,9

VKW Vorarlberg 76,4 % Land Vorarlberg; 20,4 % privat; 3,2 % Gemeinden

2,6

STEWEAG Steiermark 75 % Land Steiermark;

25 % EdF 6,2


Austrian Power Industry


Applications to real world cases

Car industry Renault – Volvo vs Renault – Nissan DaimlerChrysler, BMW + Rover General Motors: Decline and Fall Continued. Toyota’s stock market value is 15 times that of GM




Nokia and Siemens On June 19th Nokia, a Finnish firm specialising in wireless communications, and Siemens, a German company strong in fixed-line telecoms, agreed to pool their network-equipment divisions in a joint venture. Other units, such as mobile handsets, are not part of the deal. The new firm, called Nokia Siemens Networks and based in Finland, will be the world's third-largest telecoms-equipment maker, with sales of around €16 billion ($20 billion) and 60,000 employees (of whom as many as 15% will be laid off). The firm expects the overall market for equipment and services to grow in five years to more than €130 billion, from around €100 billion last year. By joining forces, the companies believe they can develop integrated products for telecoms operators vying to sell a “quadruple play” of fixed-line, broadband internet, wireless and television. The new firm will benefit from economies of scale to compete against Asian rivals, explained Klaus Kleinfeld, the boss of Siemens. By being third-largest, the firm will “have an attitude of a challenger,” said Olli-Pekka Kallasvuo, who became Nokia's chief executive on June 1st. The melding of services is happening fast. Just this week O2, a mobile operator owned by Spain's Telefónica, bought a British broadband firm for £50m ($92m), and Warner Music said it would begin to sell music to subscribers of China Unicom, a big mobile operator. This month Orange, France Telecom's mobile-phone division, began bundling communications packages with its parent's broadband unit. In America AT&T will start selling an internet-and-television service in July. The Chinese threat. In the midst of such convergence—as well as a shrinking customer base and plummeting prices—telecoms-equipment makers have started to join forces too. In October Sweden's Ericsson bought bits of Marconi in Britain for around $2 billion. In April Alcatel of France said it would buy America's Lucent for around $14 billion. Those mergers seemed to be more about size than synergy. Only the Nokia and Siemens deal combines companies with strong positions in different parts of the industry. Yet the central reason for all the deals is falling prices. “We have seen a 70% price drop in 3G infrastructure over the past five years,” explains Bengt Nordstrom, of inCode, a telecoms consultancy.




Emerson Emerson's story was recounted last year in “Performance without Compromise”, a book written by Charles “Chuck” Knight, the man who led the company through most of an unbroken run of continually rising earnings per share between 1957 and 2000. At first sight, Emerson looks like a company in which organisation man would feel at home. “Planning and control are central to the way Emerson works,” according to Mr Knight. More than half his time was taken up with planning, much of it spent in long, confrontational meetings with the company's division heads, where budgets and projections were torn apart and redrawn. This compelled the company to maintain a relatively large number of staff at its headquarters in St Louis. Emerson's employees are loyal. The average length of service of its top 15 managers is a hefty 26 years, and promotion tends to be from within. Communication, says Mr Knight, is kept to a minimum: “Our planning and control cycle provides ample opportunity to communicate the most important business issues...we don't burden our system with non-essential communications and information.”




General Electric GE has long been the exception that proved the conglomerate rule: the firm really was worth more than the sum of its parts. Now, GE's shares no longer trade at a premium to the market. Some board members have even begun to talk privately about a “conglomerate discount”. GE's industrial and financial halves used to help each other. GE Capital got the benefit of a triple-A rating; GE's industrial units got a captive finance company. But now, GE Capital has far outgrown its old captive-finance role. And increasingly, investors want to peer through GE's results to the health of GE Capital's balance sheet. Like it or not, the markets act as if the triple-A rating has already gone. The costs of sticking together, meanwhile, are mounting. GE's industrial businesses are clearly set for a miserable few years. However the firm configures itself, shareholders and creditors will punish any outperformance of the finance businesses over the anaemic industrial side. The jet engines and power plants have become a millstone around GE Capital's neck. This points to a simple conclusion: break up the company and set GE Capital free. The markets are not demanding it, but it may be only a matter of time. Mr Immelt should seize the initiative, not wait to be forced into action. “Control your destiny”, goes the title of one adoring book on GE management, “or someone else will.”



Outsourcing Jörg Ohnemus, Does IT Outsourcing Increase Firm Success? An Empirical Assessment using firmlevel data, ZEW, 2007


Outsourcing of the EU in 2006 Outsourcing (2004) versus firm size (Germany)


Summary of Empirical Studies


Prozent Prozent Funktion/Leistung mit Mehr- ohne Mehr- fachnennungen fachnennungen Produktion/Fertigung, Einkauf 22, 157 % 11,719 % Logistik/Transport/Distribution 14,558 % 7,699 % Administration (Auftragsverwaltung, Mahnwesen, Lohn- und Gehaltsverrechnung, Versorgungsdienste)18,672 % 9,876 % Kundenbetreuung, -dienst, Call Center 6,454 % 3,414 % Dienstl. (Kantine, Sicherheitsdienst,Instandhaltung,...)25,677 % 13,581 % Corporate Services, Facilities Operations und Management, Umweltmanagement 13,631 % 7,209 % IT- und Kommunikationsdienstleistungen, EDV, E-Commerce, Backoffice, Informations- und Wissensmanagement 45,274 % 23,946 % Human Resources, Aus- und Weiterbildung der Mitarbeiter 14,584 % 7,714 % Marketing(Verkauf, Werbung, Marktforschung) 7,704 % 4,075 % Rechnungswesen, Finanzdienstleistungen, Vermögens-, Wertpapiermanagement, Immobilienverwaltung 13,442 % 7,110 % Forschung & Entwicklung 2,350 % 1,243 % Andere Funktionen/Leistungen 4,567 % 2,415 %


Offshoring



For whom the Dell tolls (Economist, May 11th, 2006)

The world's biggest computer-maker is stumbling. The former advantages (no inventory, no shops, tight links to Intel) turn into a liability.



Choosing the United States by Michael E. Porter and Jan W. Rivkin HBR, March 2012, 81-93

Economics of Outsourcing The economics of moving business activities out of the U.S. to another location can be thought of in terms of a discounted cash flow analysis, like the one depicted here. After an initial investment required for the move (yellow), a firm expects to benefit from extra cash flow each following year (magenta). However, if the company encounters hidden costs, the actual cash flow (aqua) may be less than hoped for. In the short term, relocating may create extra direct costs (light gray) due to factors such as the need to hire more workers than planned. The indirect costs at a new location may also be unexpectedly high (dark gray)—for instance, because the company failed to foresee the need for additional supervision and training. Other hidden direct and indirect costs may emerge in the long run. For instance, direct labor costs can increase as wages in the new location rise more than expected. Indirect costs may increase over time due to factors such as the unanticipated loss of intellectual property. The result is that an offshoring move projected to generate a positive net present value can turn out to be a money loser.



Offshoring and Reshoring The Economist, January 19th, 2013



Services



HBS survey

HBS alumni survey respondents evaluated in which areas the U.S. is falling behind other advanced economies, keeping pace, or pulling ahead. Important U.S. strengths continue to be higher education, entrepreneurship, innovation infrastructure, and IP rights, among others. In many areas, however, such as macroeconomic policy and availability of skilled labor, the outlook is troubling.



Outsourcing Austria, Germany and Switzerland (Alexander Röck)

Interview of 200 Austrian managers by Dietmar Fink (Inst. of Management and Consulting Science). 80% have carried out outsourcing In 95% these decisions were taken by top management.



Outsourcing Austria, Germany and Switzerland (Alexander Röck)

Evaluation: 35% of Austrian managers rate their outsourcing projects as unsuccessful or failed 9% are even unable to assess the results



Motives



Conceived Problems


integration - mergers &...

Documents