j370 final notes

7/28/2019 J370 Final Notes

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J370 Final Notes

Article: Structure is not organization

I. Paying attention provides a stimulus to productivity, more so that formal rewardsI.

The 7-S Frameworka. Key insights

i. Not just strategy and structure 5 other important factorsii. Mutual interdependency

iii. Failure can be attributed to one or any combinationiv. Circle emphasizes the absence of hierarchyv. Focus on qualitative factors

vi. More holistic, less environmentalb. Strengths

i. Very comprehensiveii. Focus internally

iii. Must mange both hard and soft aspectsiv. Coordinate tasksv. Firm as a social system

c. Weaknessesi. May miss the fine-grained areasii. Difficult to assess

iii. Little empirical supportiv. How to implementv. Very static unless used intermittently

d. Abouti. To perform well, all the elements must be aligned and be mutually reinforcingii. Organizational elements are inter-related

iii. Hard elements: can directly influence1. Structure2. Strategy3. Systems

iv. Soft elements: less tangible1. Skills2. Shared values3. Staff4. style

A. Structurea. Divides tasks then provides coordination; trades off specialization and integration; it

decentralizes then recentralizes

b. Way in which tasks and people are specialized and divided, and authority is distributedc. Basic grouping of activities and reporting relationships into organizational sub-unitsd. Mechanisms by which the activities of the members of the organization are coordinated

B. Strategya. Direction and scope of the firm through which competitive advantage will be achieved

C. Systems


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a. Formal and informal process and procedures used to manage the organization, including themanagement control systems, performance measurement and reward systems, planning,

budgeting and resource allocation systems, information systems, and distribution systems

D. Stylea. Leadership style of top management and the over all operating style of the organizationb.

Style impacts the norms people follow and how they work and interact with each other andwith customers

E. Staffa. People, their backgrounds and their competenciesb. Organizations approaches to recruitment, selection, and socializationc. How people are developed; how recruiters are trained, socialized, and integrated; and how

their careers are managed

F. Skillsa. Distinctive capabilities and competencies that reside in the organization and are what the

organization does best

b. Typically distinctive competencies of people, but can also include management practices,systems, and/or technology

G. Super-ordinate goalsa. The core or fundamental set of values that are widely shared in the organization and serve

as guiding principles of what is important

b. Usually communicated in simple ways, and may even seem trivial from the outsidec. But to the organizations members, values have great meaning because they help focus

attention and provide a broader sense of purpose

Managing Knowledge

II. What is the value of intellectual CapitalA. Intellectual capital: knowledge that can be stored for use laterB. Knowledge: information that can be connected to intentionC. According to professor Quinn, information is the source of 75% of value-added in manufacturing

firms

III. Why is knowledge an increasingly important source of sustainable advantage?A. The global economy is becoming a knowledge-based economyB. Knowledge is a competitive advantage if it is unique and valuable

a. Many observers are arguing that knowledge is the most likely resource to be unique andtherefore the most likely to create sustained advantage

C. Knowledge is the result of a learning processa. Knowledge management focuses on connecting all four parts of the learning process which

are required to pass the benefit from one individuals learning to others

b. When this is accomplished, the value of individual learning and collective learning increasewith use

i. opposed to most assets whose value diminishes with useii. knowledge has been said to appreciate at every stage in the value chain

1. concrete experience2. observation and reflection3. forming abstract concepts4. testing in new situations


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a. this is the learning processb. 1 and 2 are guaranteed to happen, however 3 and 4 are not

D. Human Capital theorya. Examines the role of the individuals competence, focusing on how an individuals knowledge

enhances cognitive abilities and can result in more effective activities

b.

Considers how knowledge is developed and used at the individual levelc. Knowledge is the only asset that can help a firm adapt to radical change as markets shift,

uncertainty dominates, and technologies proliferate

i. The firms that succeed in these difficult, sometimes hypercompetitiveenvironments are able to create and disseminate new knowledge quickly and

embody knowledge in their products and services

E. Knowledge-based systems and processes have the greatest promise for long-term growthIV. What are the characteristics of knowledge needed by companies?

A. Hierarchy of knowledge, information, and dataa. Knowing how to use information is what makes knowledge a resourceb. Knowledge: uses information to support direction or intent; created when strategists use

information to do somethingc. Information: data connected with a connect that enables insight, analysis and conversationd. Data: raw input to knowledge; background, rarely valuable in and of themselves (i.e. facts,

numbers)

e. Most of the costs to develop and distribute knowledge is in the creation processi. Once knowledge is created, initial development costs can be spread across rising

volume, and advantages from use can endure over time

ii. Knowledge is an asset that can become more valuable as more people use it andadd to it

f. It is difficult to determine who owns knowledgei. Intellectual property rights: are knowledge resources that can be legally protected

and thus potentially used for competitive advantageg. Valuable knowledge tends to be private and tacit

B. Public vs. Private Knowledgea. Public knowledge: is openly available and not the unique property of any one firm

i. Best practices: methodologies or techniques that have, through research andexperience, been proven to lead to desired results

1. Necessary for survival in a highly competitive marketplaceii. Promising practices: alternative label for best practices that emphasizes the

importance of adaptation to local circumstances

iii. Widely available knowledge is not a source of competitive advantage unless thecompany figures out a different way to use that knowledge or applies it more

faithfully than competitorsiv. Failure to apply public knowledge can be a source of competitive disadvantage

b. Private knowledge: can be protected form others, and includes a firms unique routines,processes, documentation, and trade secrets

i. Only private knowledge can be a source of competitive advantageC. Explicit vs. Tacit knowledge

a. Explicit: based on objective information and observable skills that can be easily taught orwritten down


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b. Tacit: developed through experience and depends on an individual or group insight andintuition; more difficult to transfer to others and requires interactive experience

i. Though more difficult to strategically manage, tacit knowledge can be the mostvaluable knowledge to a company because it can create a sustained competitive

advantage

D.

Human Capital and Social Capitala. Human capital: role of individuals competence (education, on the job experience)b. Social Capital: individuals position in a social network of relationships and the resources

embedded in, available through, or derived from these networks

V. How do strategists manage and use knowledge?a. Taking the new learning of employees and making it available to others in the organization is the

central activity of the knowledge-creating company

i. Requires finding methods to combine traditional resources and capabilities in new andunique ways

ii. An organizations ability to acquire, integrate, share and apply knowledge becomes tomost important strategic resource for creating a sustainable competitive advantage

b. Organizations need to develop a formal knowledge management processi. Indentifying what information a company has and developing approaches to make

useful information available to organization members

A. Knowledge creationa. The organization cannot create knowledge without individuals

i. The organization provides the structure and support for individuals to createknowledge

b. Socialization: (tacit tacit)i. describes the experience-sharing process of conveying tacit knowledge from one

person to another, whereby a more experienced individual communicates mental

models, technical skills, and other tacit knowledge

1. Occurs through dialogue, observation, imitation, and practiceii. New knowledge can result when an individual obtains information from another

person, and this triggers an entirely new idea

iii. As firms interact more with their customers, a socialization process is occurringc. Externalization: (tacit explicit)

i. Defined as the process of translating tacit knowledge that some individuals possessinto knowledge that can be readily understood by others (explicit)

ii. Firm needs to take knowledge, test it, then transfer it other individuals1. Usually a group process

d. Combination: (Explicit explicit)i. explicit knowledge is integrated and recombined

ii. existing explicit knowledge is usually recataloged and expanded into new explicitknowledge

e. internalization: (Explicit Tacit)i. describes the process of taking explicit knowledge and translating it into tacit

knowledge, which can make it easier for individuals to act upon

f. spiral of knowledge:i. using all four types of knowledge to create activities that are simultaneously

occurring and interacting with each other


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ii. occurs when socialization, externalization, combination, and internalization becomean ongoing interactive process of learning

B. Knowledge storagea. Organizational memory: the collective knowledge available from a variety of explicit and

tacit knowledge resources

i.

Written documents, structured electronic databases, documented firm processes,tacit knowledge, etc.

b. Memory is importanti. Memory may not supply the exact solution to a new problem, but it facilitates

absorptive capacity (the firms ability to evaluate, assimilate, and apply new

externally gathered information that is dependent on prior related info)

c. Two strategies for storing knowledgei. Codification

1. Computer-centric2. Firms knowledge is stored in electronic databases

a. Electronic databases store three general classifications infoi. External knowledge

ii. Formal internal knowledgeiii. Informal internal knowledge

ii. Personalization1. People-focuses2. Knowledge is shared through personal contacts (i.e. consultants)

C. Knowledge transfera. The firms ability to retrieve and distribute knowledgeb. Transfer conduits

i. Informal: water cooler conversations1. Promote socialization2. Not effective for firm wide transfer

ii. Formal: group training sessions1. Guarantee widespread transfer2. May inhibit creativity

iii. Personal: internships, shadowing1. Enable sharing of context-specific knowledge

iv. Impersonal: electronic knowledge databases1. Effective for explicit knowledge2. Explicit knowledge = easy to transfer

c. Signature Processes: unique value-creating practices that resonate with the leaders valuesand the unique history of the organization

D. Knowledge usea. Technological components of knowledge use

i. Include groupware, integrated e-mail, discussion groups or newspapers, videoconferences, electronic databases, intranets and extranets

ii. Effective and implementable knowledge management technical solutions arecomparatively easy to evaluate and purchase, and they provide multiple benefits to

the firm

b. Organizational components of knowledge use


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i. glue of an organizationii. Includes organizational culture, incentive systems, compatible organization design,

and individual competencies

iii. Learning organization: an organization that is able to create, acquire, interpret,transfer, and retain knowledge to purposefully improve the value they create

VI.

How do organizational systems affect knowledge management?A. Corporate culture and values

a. Establishing a supportive learning environment is developing a corporate culture capable ofpromoting innovation, risk taking, and collaboration

b. The culture must encourage individuals to share their knowledge and learning throughoutthe organization

B. Incentive systemsa. Intrinsic rewards: internally focused

i. Based on personal motivations such as a desire to help others or to build self-esteem

b. Extrinsic rewards: externally focusedi. Visible to others

1. Financial incentives and public recognitionC. Organizational structure

a. Must use structure that allows for a quick response time to customer needs and changes inmarket conditions

i. Shorter time to market, higher levels of creativity and innovation, mechanisms forongoing learning, and the quick adaptation of new technologies

b. Organizations that encourage learning and innovation have two important characteristics:i. And increasing reliance on networks of personal relationships

ii. And the use of smaller operating unitsD. Recruitment

a. Employees must have the ability to be self-learners and their willingness to share thatknowledge and work in teams

VII. What are the most important external sources of knowledge?a. KM has an equally important external face: acting as the connection between the firm and its

stakeholders, especially customers

i. It is also the distinguishing factor among competitors in a knowledge communityA. Benchmarking

a. Focuses on collecting data and other intelligence that permits comparisons with other firmswithin or outside an industry to identify how well ones firms is performing its basic function

or activities

b. The objective of benchmarking is to identify best (or promising) practices and to take actionsthat improve the firms competitive position

B. Contingent employeesa. Independent contractors who are brought into the firm as consultants or on-call workers to

accomplish a specific task

b. Can cut the firms operating costs by reducing benefit costs, recruitment costs, employeeturnover, and paid-yet-underutilized hours

c. Two key disadvantages


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i. Workers may learn about your firm and transfer important competitive knowledgefrom your firm to competitors

ii. The firm may not have the processes in place to capture the knowledge andlearning that the contingent workers have to offer, so once their job is finished,

continuity is lost

C.

Strategic alliancesa. Cooperative arrangements with other organizationsb. Increase a firms knowledge base more quickly and cheaply than outsourcingc. Includes research consortiums, joint ventures, long-term supplier relationships, and licensing

arrangements

d. Allow firms to extend their spheres of influence beyond the assets they own and to leveragethe assets of others to create greater value while minimizing their own capital outlays

e. Most important problem: identifying important knowledge and transferring it from theoutside environment does not take place automatically

D. Distributed expertisea. Not all the smart people work for one company

Corporate Governance

VIII. IntroA. Definition: the set of mechanisms used to manage the relationship among stakeholders and

determine and control the strategic direction and performance of an organization

o Concerned with identifying ways to ensure that strategic decisions are made effectivelyo Establishes order between partieso Reflects and enforces the companys values

B. Separation of ownership and managerial controlb. Historically, firms were managed by founder-owners and descendentsc. Separation of ownership and managerial control allow shareholders to purchase stock, entitling

them to income (residual returns)i. Implies risk for this group who mange their investment risk

d. Shareholder value reflected in price of stocke. The separation and specialization of ownership (risk bearing) and managerial control (decision

making) should produce the highest returns for the firms owners

f. Small firms managers are high percentage owners, which implies less separation betweenownership and management control (usually family owned)

i. 2 critical issues1. As they grow, they may not have access to all needed skills to mange the

growing firm and maximize its returns, so may need outsiders to improve

management

2. May need to seek outside capital (and give up some ownership control)D. Why do we need governance

a. Shareholders (principal)i. Provide funds

ii. Owners with limited liabilityiii. Limited involvement

b. Managers (agents)i. Run the corporation without providing fund


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ii. Responsible for working for shareholders (principals)iii. Receive employment and pay

c. Board of directorsi. Approves major decisions

ii. Oversees top managementiii.

Duty to protect shareholders

E. Agency Relationshipsa. Relationship between business owners (principals) and decision making specialists to

perform a service

i. i.e. to manage principals operations and maximize returns on investmentii. clients/consultants; insurer/insured; employee/manager

b. problems can surface because the principal and the agent have different interests and goalsor because shareholders lack direct control of large publicly traded corporations

c. problems also arise when an agent makes decisions that result in the pursuit of goals thatconflict with those of the principal

d. shareholders want high returns/ high riske. can lead to managerial opportunism

i. managerial opportunism: the seeking of self-interest with guile1. both an attitude and a set of behaviors2. principals do not know before hand which agents will or will not act

opportunistically

f. product diversification: a potential agency problemi. two manager benefits that shareholders dont enjoy

1. increase in firm size (which often increases compensation)2. firm portfolio diversification can reduce top executive employment risk

(i.e. job loss, loss of compensation or reputation)

ii. diversification reduces these risks because a firm and its managers are lessvulnerable to the reduction in demand associated with a single or limited number ofproducts lines or businesses

iii. free cash flows1. remaining resources after the firm has invested in all projects that have

positive net present values within the current business

2. managers want to use to over-diversify the firm (opportunistic)3. shareholders think they should be distributed as dividends, so they can

control how the cash is invested

iv. in general1. shareholders prefer riskier strategies and more focused diversification2. top executives prefer a level of diversification that maximizes firm size and

their compensation and that reduces employment riskg. agency costs and governance mechanisms

i. potential conflicts coupled with the fact that principals do not know whichmanagers might act opportunistically, demonstrates why principals establish

governance mechanisms

ii. the firm incurs costs everytime it uses one or more governance mechanisms


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iii. agency costs: the sum of incentive costs, monitoring costs, enforcement costs, andindividual financial losses incurred by principals because governance mechanisms

cannot guarantee total compliance by the agent

iv. if a firm is diversified, governance costs increase because it is more difficult tomonitor what is going on inside the firm

v.

these costs should be associated with improved managerial decision-making andstrategic effectiveness

h. agency vs stewardshipi. stewardship

1. executives motivated to act in best interest of the corporation that theirown self-interests

2. over time senior executives tend to view corporation as extension of selvesii. agency

1. objective of owners/ shareholders and agents in conflict2. difficult for owners to verify agent performance

II. Ownership ConcentrationA. Ownership Concentration: The number of large block shareholders and the total percentage of shares

they own

B. Large-block shareholders: typically own at least 5 percent of corporations issued sharesC. Diffuse ownership: a large number of shareholders with small holdings and few, if any, large-block

shareholders

g. Produces weak monitoring of managers decisionsE. Institutional owners: financial institutions such as stock mutual funds and pensions funds that

control large-block shareholder positions

a. Pension funds alone control at least one-half of corporate equityF. The growing influence of institutional owners

a. Provides size to influence strategy and the incentive to discipline ineffective managersb. Increased shareholder activism supported by SEC rulings in support of shareholder involvement

and control of managerial decisions

III. Board of DirectorsA. Group of elected individuals that acts in the owners interests to formally monitor and control the

firms top-level executives

B. Responsible to:h. Evaluate and advise

i. Set strategy and direct the organizationii. Ensure resources are managed well

i. Monitor and controli. Hire, fire, punish and reward managersii. Protect owners from managerial opportunism

iii. Supervise executives and set compensationj. Plan and provide

i. Use social connections for the firmii. Provide personal knowledge

iii. Determine the firms direction and missionC. Types of directors

a. insiders


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i. active top-level managers in the corporation who are elected to the board because they

are a source of information about the firms day-to-day operations

b. related outsiders

i. have some relationship with the firm, contractual or otherwise, that may create questions

about their independence, but these individuals are not involved with the corporations day-

to-day activitiesc. outsiders

i. provide independent counsel to the firm and may hold top-level managerial positions in

other companies or may have been elected to the board prior to the beginning of the

current CEOs tenure

D. Board of directors involvement (low to high)

a. phantom: no degree of involvement

b. rubber stamp: officers make decisions, board votes on those decisions

c. minimal review: formally reviews certain issues that officers bring to attention

d. nominal participation: involved to a limited degree in the performance or review of selected key

decisions, indicators or programs of management

e. active participation: approve questions, makes final decisions on mission, strategy, policies andobjectives. Performs fiscal and management audits

f. catalyst: takes the leading role in establishing and modifying the mission, objectives, strategy, and

policies. Very active strategy committee

E. other BOD shit

k. Historically, BOD dominated by inside managersl. Managers were suspected of using their power to select and compensate directorsm. NYSE implemented an audit committee rule requiring outside directors to head audit committeesn. Sarbanes-Oxley Act passed leading to BOD changeso. CG becoming more intense through BOD mechanismp. BOD scandals led to trend of separating roles of CEO and chair person

G. Outside directorsa. Improve weak managerial monitoring and control that corresponds to inside directorsb. Tend to emphasize financial controls, to the detriment of risk related decisions by

managers, as they dont have access to daily operations and a high level of information

about managers and strategy

c. Large number of outsiders can create problemsi. Limited contact with the firms day-to-day operations and incomplete information

about managers

1. Results in ineffective assessments of managerial decisions and initiatives2. Emphasizes financial, as opposed to strategic, controls to gather

performance information to evaluate performance of managers and

business units, which could reduce R&D investments, increasediversification, and pursue higher compensation to offset their

employment risk

H. Interlocking Directoratea. CEOs often nominate executives or other board members to create an interlocking

directorate

i. May provide informationii. May be used for collusion


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b. Direct interlocking: 2 boards of directors share at least 1 director in commonc. Indirect interlocking: 2 boards are linked through sitting on another board

I. Enhancing the effectiveness of the BOD recent changesa. Increased diversity in board members backgroundsb. Establishment and consistent use of formal processes to evaluate the boards performancec.

Creation of a lead director that has strong agenda-setting and oversight powers

d. Modified compensation of directorse. Requires that directors own significant stakes in the company in order to keep focused on

shareholder interests

IV. Executive compensationA. Executive compensation: governance mechanism that seeks to align the interests of top managers

and owners through salaries, bonuses, and long-term incentive compensation, such as stock awards

and stock options

a. Thought to be excessive and out of line with performanceb. Alignment of pay and performance: complicated board responsibilityc. The effectiveness of pay plans as a governance mechanism is suspect

B. Effectiveness of executive compensationa. Complicated, especially long-term incentive compensation

i. Quality of complex and non-routine strategic decisions that top-level managersmake is difficult to evaluate

ii. Decisions affect financial outcomes over an extended period, making it difficult toassess the effect of current decisions on corp performance

iii. Many external factors affect a firms performance in addition to top-levelmanagement decisions and behavior

iv. Performance-based compensation used to motivate decisions that best serveshareholder interests are imperfect in their ability to monitor and control managers

v. Incentive-based compensation plans intended to increase firm value, in line withshareholder expectations, subject to managerial manipulation to maximizemanagerial interests

vi. Many plans seemingly designed to maximize manager wealth rather than guaranteea high stock price that aligns the interests of managers and shareholders

b. Stock options are highly popular as compensationi. Re-pricing: strike price value of options is commonly lowered from its original

position

ii. Back-dating: options grant is commonly dated earlier than actually drawn up toensure an attractive exercise price

V. Market for Corporate ControlA. Market for corporate control: external governance mechanism consisting of a set of potential

owners seeking to acquire undervalued firms and earn above-average returns on their investmentsa. Becomes active when a firms internal controls fail

B. Need for external mechanisms exists to:a. Address weak internal corporate governanceb. Correct suboptimal performance relative to competitorsc. Discipline ineffective or opportunistic managers

C. External mechanisms are less precise than internal governance mechanismsD. Managerial defense tactics


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a. Hostile takeovers are the major activityi. Not always due to poor performance

b. Defense strategiesi. Poison pill: preferred stock in the merged firm offered to shareholders at a highly

attractive rate of exchange

1.

Preventive measure2. High popularity3. High effectiveness4. Positive stockholder wealth effects

ii. Corporate charter amendmentiii. Golden parachuteiv. Litigationv. Greenmail

vi. Standstill agreementvii. Capital structure change

Article: Extending the easy Business Model: What should easyGroup do next?

Ch 9: Strategic Alliances

What is a Strategic alliance?

A. There are only three ways for a company to growa. Internal development (growth from within)

i. Slowest routeb. Strategic alliances / joint venturesc. Merger / acquisition (next chapter)

i. Quickest route / most riskyB. Using alliances reduces costs

a. Create economic value by:i. Accessing complementary resources and capabilitiesii. Leveraging existing resources and capabilities

b. An alliance is an organizational form of exchange that should:i. Produce a gain from trade due to some comparative or absolute advantage

1. Implication: choose partners that are better at something than you are(complementary resource)

C. Strategic alliance: exists whenever two or more independent organizations cooperate in thedevelopment, manufacture or sale of products of services

a. Nonequity Alliance: cooperating firms agree to work together to develop, manufacture, or sellproducts or services, but they do not take equity positions in each other or form an independent

organizational unit to manage their cooperative effortsi. These cooperative relations are managed through the use of various contractsii. EXs:

1. Licensing agreements: where one firm allows other to use its brand name tosell products

2. Supply agreements: where one firm agrees to supply others3. Distribution agreements: where one firm agrees to distribute the product of

others


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b. Equity Alliance: cooperating firms supplement contracts with equity holdings inn alliancepartners

i. Very common in the biotechnology industryii. One company wont screw the other over because both hold ownership

c. Joint venture: cooperating firms create a legally independent firm in which they invest and fromwhich they share any profits that are created

i. AT&T and BellSouth created Cingular; AT&T owns 60%, BellSouth owns 40%ii. A 3rd company is formed with a parent company and joint owner

1. Less liable for parent company than creating on their ownHow do strategic alliances create value?

A. Like all strategies discussed, strategic alliances create value by exploiting opportunities and neutralizingthreats facing the firm

B. Strategic alliance opportunitiesa. Opportunities to improve performance of its current operations

i. Exploiting economies of scale1. Economies of scale: when the per-unit cost of production falls as the volume of

production increases2. A partner brings increased market share and/or manufacturing capacity3. When a firm cannot realize the cost savings from economies of scale all by

itself, it may join in a strategic alliance with other firms

4. If the volume of production required to realized these economies of scale isvery large, a single firm might have to dominate an entire industry to obtain

these advantages

a. This is very difficultb. Govt might impose anti-monopoly regulations

ii. Learning from competitors1. A partner brings technology and/or market knowledge2. Different firms in an industry have different resources and capabilities3. Firms that are at a competitive disadvantage may want to form alliances with

firms that have an advantage in order to learn about their R&Cs

4. EX: GM (plant operations) and Toyota (lean manufacturing)a. When both parties to an alliance are seeking to learn something from

that alliance, an interesting dynamic called learning race can evolve

iii. Managing risk and sharing costs1. A partner bears a portion of the risk and/or cost of the alliance2. EX: HBO producing TV shows with independent producers

a. Share risk and costs but also share profitsb. Opportunities to Create a competitive environment favorable to superior performance

i. Facilitating the development of technology standards1. Partners may agree on a standard and avoid a market battle for the standard

a. EX: Blue Ray (SA btwn sony, sharp, apple and tdk) vs HD-DVD2. Standards can also be set by letting consumers decide which they prefer

a. EX: betamax vs. VHS3. Important in network industries

a. Characterized by increasing returns to scale


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i. The value on each product increases as the number of theseproducts increases

ii. Facilitating tacit collusion1. Partners may communicate with an alliance in subtle, legal ways whereas the

same communication between competitors outside an alliance would be illegal

2.

Collusion: exists when two or more firms in an industry coordinate theirstrategic choices to reduce competition in the industry

3. Explicit collusion: exists when firms directly communicate with each other tocoordinate their levels of production, their price, and so forth

4. Tacit collusion: exists when firms coordinate their production and pricingdecisions, not by directly communicating with each other, but by exchanging

signals with other firms about their intent to cooperate

a. Signal: public announcementc. Opportunities to facilitate entry and exit

i. Most valuable when markets are uncertainii. Low-cost entry into new industries and new industry segments

1. A partner provides instant access and legitimacy2. Partner with an experienced firm in the industry attempting to enter: this will

reduce the costs and difficulty of breaking into a new industry

iii. Low-cost exit from industries and industry segments1. A partner is an informed buyer2. When a firm exits an industry, they must sell all their assets

a. If they previously had a strategic alliances, their partner will be morewilling to buy these assets for an appropriate price

iv. Managing uncertainty1. Alliances may serve as real options2. EX: Disneys partner with Pixar b/c uncertainty with computer technology

v. Low-cost entry into geographic new markets1. Partners provide local market knowledge, access, and legitimacy with

governments and customer

Alliance Threats: Incentives to cheat on Strategic Alliance

A. 1/3 of all strategic alliances do not meet the expectations of at least one alliance partnerB. Incentives to cheat an alliance when it is an exchange context in which:

a. Partner inputs may be difficult to monitorb. Actual value creation (performance) may be difficult to monitorc. Value appropriation (allocating value) may be difficult to monitor or subject to power dynamics

C. Adverse Selection: exists when an alliance partner promises to bring to an alliance certain resources thateither does not control or cannot acquire

a. Potential partners can misrepresent the skill, abilities, and other resources that they will bring toan alliance

b. The less tangible the R&C that are to be brought to a strategic alliance, the more costly it will beto estimate their value before an alliance is created, and the more likely it is that adverse

selection will occur

c. Firms considering alliances that bring intangible resources such as contacts with key politicalfigures or knowledge of local conditions will need to guard against cheating


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D. Moral Hazard: partners in an alliance may possess high-quality R&Cs of significant value but fail to makethose R&Cs available to alliance partners

a. EX: partner says theyre sending their most experienced and best trained engineers, but thendoesnt

i. These less talented engineers then learn a great deal from the highly qualified engineersprovided by other alliance partners

E. Holdup: when on firm makes more transaction specific investments in a strategic alliance than thepartner firm makes

a. Once a strategic alliance has been created, partner firms may make investments that have valueonly in the context of that alliance and in no other economic exchanges

b. Transaction specific investment: when an investments value in its first-best use (in this case,within the alliance) is much greater than its value in its second-best use (outside the alliance)

c. Holdups occur when a firm that has not made significant transaction specific investmentsdemands returns from an alliance that are higher than originally agreed

Strategic Alliances and Sustained Competitive advantage

A. Rarity of Strategic Alliancesa. Depends on the number of competing firms that have already implemented strategic alliances

AND whether the benefits that firms obtain from their alliances are common

b. One reason why the benefits that accrue from a particular strategic alliance may be rare is thatrelatively few firms may have the complementary resources and abilities needed

i. This is likely when an alliance is formed to enter into a new market, especially a newforeign market

B. Imitability of Strategic Alliancesa. Direct duplication

i. Successful strategic alliances are often based on socially complex relationships amongalliance partners

1. This is hard to duplicate, thus if you have it, you have a competitive adv.b. Substitution

i. Going it alone1. When firms attempt to develop all the resources and capabilities they need

them selves

2. Substitute when going it alone creates the same or more value than usingalliances

a. Called vertical integration3. Not a substitute when it does not create more value4. Alliance will be preferred over going it alone when:

a. The level of transaction-specific investment required to complete anexchange is moderate

b. An exchange partner possessed valuable, rare, and costly-to-imitateR&Cs

c. There is great uncertainty about the future value of an exchangeii. Acquisitions

1. Rather than developing a strategic alliance, a firm seeking to exploitopportunities may simply acquire another firm that already has the relevant

R&Cs


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2. 4 characteristics that limit the extent to where acquisitions can be a substitutefor strategic alliances

a. There are legal constraintsb. Acquisitions limit a firms flexibility (in exiting and entering) under

conditions of high uncertainty

c.

There is substantial unwanted organization baggage (parts of thefirm that do not create value) in an acquired firm

d. The value of a firms R&Cs depends on its independenceC. Organizing to implement strategic alliances

Tools and mechanisms to help realize the value of alliances and minimize the threat of cheating

a. Explicit contracts and legal sanctions (formal/codified)i. A way to avoid cheating is to anticipate the ways in which cheating could occur and to

write explicit contracts that define legal liability if cheating does occurs

ii. Such strategic alliances are called nonequity alliancesiii. However, parties cannot always foresee all forms of cheatingiv. Creates mutual understandingv. Imposes costs for cheating

b. Equity Investments (formal/codified)i. Aligns the interest of partners through ownership in each otherii. Indirect effect

iii. The effectiveness of contracts can be enhanced by having partners in an alliance makeequity investments in each other

iv. These kinds of strategic alliances are called equity alliancesv. Cross-equity investments

1. Where a firms largest equity holders often include several of key suppliersincluding main banks

2. Can reduce supply costs as well as risk of cheatingc. Firm reputations (informal)

i. Information about an alliance partner that has cheated is likely to become widely knownand effect their reputation

ii. Limitations to cheating ruining a reputation and thus a firms future businessopportunities

1. Subtle cheating may not become public2. Cheating my not be subtle or ambiguous, but the firm could be apart of a

network in which the information is neglected to be made public

3. A non subtle and unambiguous cheating firm which is made publically knownmay incur large losses due to the lost alliance

a. Thus, their ruined rep is the least of their problemsd. Joint Ventures (formal/codified)

i. Aligns interests of partners through ownership of independent firmii. Direct effect

iii. Investing in a joint venture reduces the chance of cheating to occuriv. All partners are heavily invested and rely on profits, so they dont cheatv. However, sometimes the gain form cheating is larger than the loss that would occur

from losing the joint venture, so they cheat anyways

e. Trust (informal)


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i. May allow partners to exploit opportunities that would be infeasible with othermechanisms

ii. Trust in combination with contracts can help reduce the threat of cheatingiii. Best way to create a sustained competitive advantage in strategic alliance

Extra Notes

A.

Corning and Cisco are the most well known for their strategic alliance successB. Vertical complementary strategic alliance

a. Formed between firms that agree to use their skills and capabilities in different stages of thevalue chain to create value for both firms

C. Horizontal complementary strategic alliancea. Formed when partners who agree to combine their resources and skills to create value in the

same stage of the value chain

b. Alliance with direct competitorsc. Most riskyd. Big risks for opportunism

D. Alliance may be attractive during expansions because:a. Local market knowledge is usually criticalb. Governments may require a local partnerc. International expansion may be:

i. Fraught with uncertainty and high riskii. Expensive

d. Alliance investment may be more easily reversed than internal development or acquisitionCh 10: Mergers and Acquisitions

Corporate level strategy should create value:

A. Such that the value of the corporate whole increaseB. Such that businesses forming the corporate whole are worth more than they would be under

independent ownershipC. That equity holders cannot create through portfolio investing

What are Mergers and Acquisitions?

A. Acquisition: when a firm purchases a second firma. Can be a controlling share, a majority or all of the target firms stockb. Can be friendly or hostilec. Usually done through a tender offerd. A firm can use its cash, debt or equity to purchase a second firm (or a mix of all)e. Or they can purchase a controlling share

i. Purchasing enough assets so that the acquiring firm is able to make all management andstrategic decisions in the target firm

f. Acquisitions and mergers are often used interchangeably but they are not synonymsg. Friendly acquisitions: occur when the management of the target firm wants the firm to be

acquired

h. Unfriendly acquisitions: occur when the management of the target firm does not want the firmto be acquired (also known as hostile takeovers)

i. Some acquisitions are accomplished through direct negotiations between an acquiring firmsmanagers and the managers of a target firm


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i. This is common in privately held firms (no IPO) and closely held firms (not sold manyshares on the public market)

j. Some acquisitions happen when a firm publicly announces they want to purchase a target firmfor more than their shares are worth

i. The difference between the current market price and the offered price is calledacquisition premium

ii. This approach is called a tender offeriii. Can be made with or without the target firms management

B. Merger: when the assets of two similar sized firms are combined; two firms are combined on a relativelyco-equal basis

a. Can occur in many of the same ways as acquisitions, but will not usually be unfriendlyb. Usually, one firm invests in share of the other and vice versac. Parent stocks are usually retired and new stock is issuedd. Name may be one of the parents or a combinatione. One of the parents usually emerges are the dominate management

The value of Mergers and Acquisitions

A. Mergers and acquisitions between unrelated firmsa. A firms shares are worth a certain amountb. Any price for a target that is less than this value will be economic profit for bidding firmc. Price = to value will be zero economic profit for bidding firmd. Price > than value is economic losses for bidding firme. There would be no expectation of value creation due to the lack of synergies between businessesf. There might be value creation due to efficiencies from an internal capital marketg. There might be a value creation due to the exploitations of a conglomerate discount

i. A corporate raider who buys and restructures firmsB. Mergers and acquisitions between related firms

a. The acq. Of related firms will generate zero economic profits for both the bidding and targetfirms

b. Value creation would be expected due to synergies between divisionsi. Economies of scaleii. Economies of scope

1. Transferring competencies2. Sharing infrastructure, etc

c. Types of strategic relatednessi. The FTC categories

1. Because mergers and acq can have the effected of increasing or decreasing thelevel of concentration in an industry, the federal trade commission is charged

with the responsibility of evaluating the competitive implications of proposed

mergers and acq2. Will disallow and potential for a monopoly3. Vertical merger: when a firm vertically integrates either forward or backward

through its acquisition efforts

a. Purchasing suppliers (forward) or customers (backward)b. Increases a firms market power by controlling additional parts of the

value chain

4. Horizontal merger: when a firm acquires a former competitor


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a. Acquisition of a company in the same industry in which the acquiringfirm competes

b. Increases a firms market power by exploitingi. Cost based synergies

ii. Revenue based synergiesc.

Acquisitions with similar characteristics result in higher performancethan those with dissimilar characteristics

5. Product extension merger: firms acquire complementary products6. Market extension merger: to gain access to new geographic markets7. Complementary acquisition: acquisition of a company in a highly related

industry or products

a. Because of the difficulty in implementing synergy, complementaryacquisitions are often difficult to implement

8. Conglomerate merger: residual category; everything else that cannot bedefined

a. Not commonb. An unrelated M&A activity

ii. Other types of strategic relatedness1. Technical economies: related in marketing, production, etc2. Pecuniary economies: related in market power3. Diversification economies: related in portfolio management and risk reduction

iii. Economic profits in related acquisitions1. If the bidding and target firms are strategically related, then the economic

value of these two firms combined is greater than separate

C. Entry Barriersa. Factors associated with the market or with the firms operating in it that increase the expense

difficulty faced by new ventures trying to enter that market

i. Economies of scaleii. Differentiated products

D. Cross border acquisitiona. Acquisitions made between companies with head quarters in different countries

i. Are often made to overcome entry barriersii. Can be difficult to negotiate and operate because of the differences in foreign cultures

E. Cost of new product development and increased speed to marketa. Internal development of new products is often perceived as high-risk activity

i. Acq allow a firm to gain access to new and current products that are new to the firmii. Returns are more predictable because of the acquired firms experience with the

products

b. An acq outcomes can be estimated more easily and accurately than the outcomes of an internalproduct development process

i. Managers may view acquisitions as lowering risk associated with internal ventures andR&D investments

ii. Acq may discourage or suppress innovationF. Increases diversification

a. Using acq to diversify a frim is the quickest and easiest way to change its portfolio of businesses


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b. Both related diversification and unrelated diversification strategies can be implemented throughacquisitions

c. The more related the acquired firm is to the acquiring firm, the greater is the probability that theacquisition will be successful

G. Reshaping the firms competitive scopea.

An acquisition can:

i. Reduce the negative effect of an intense rivalry on a firms financial performanceii. Reduce a firms dependence on one or more products or markets

1. Reducing a companys dependence on specific markets alters the firmscompetitive scope

H. Learning and developing new capabilitiesa. An acquiring firm can gain capabilities that the firm does not currently have

i. Special technology capabilityii. A broader knowledge base

iii. Reduced inertiab. Firms should acquire other firms with different but related and complementary capabilities in

order to bild their own knowledge baseWhat does research say about returns to mergers and acquisitions?

A. Target firm market value increases on average about 25% while bidding firms remain unchangedB. So why are there so many mergers and acquisitions if it only creates a competitive parity?

a. To ensure survivali. In order to not be at a competitive disadvantage, mergers and acq happen to create

competitive parity and normal economic profits

ii. Avoid scale disadvantagesb. Free cash flow

i. Free cash flow: the amount of cash a firm has to invest after all positive net presentvalue investments have been funded

ii. Firms can invest their free cash flow to create mergers and acqc. Agency problems

i. Can benefit managers even if it does not benefit equity holders1. Helps diversify their human capital2. Quickly increases firm size, measured in scale or assets

a. If management compensation is closely linked to firm size, this isbenefit for them

d. Managerial hubrisi. Managerial hubris: the unrealistic belief held by managers in bidding firms that they can

manage the assets of a target firm more efficiently than the target firms current

management

e. The potential for economic profitsi. In some situations bidding firms may be able to gain competitive advantages form

mergers and acq activities

C. Major factors in making an M&A decisiona. Managers should weight each factor depending on its importance to their industryb. First managers should look at their resources

i. Types of synergiesii. Nature of resources


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iii. Extent of redundancyc. Then the firm should look at uncertainty in the marketd. Lastly, the firm should consider competition

Merger and Acquisitions and Sustained Competitive advantage

A. Can an M&A strategy generate sustained competitive advantagea.

Yes, if managers abilities meet VIRO criteria

i. Managers may be good at recognizing and exploiting potentially value-creatingeconomies with other firms

ii. Managers may be good at doing dealsiii. Managers may be good at both

B. The market for competitive control: the market that is created when multiple firms actively seek toacquire one or several firms

a. Only when the market for corporate control is imperfectly competitive might it be possible forbidding firms to earn profits

C. Valuable, rare and private economies of scopea. An imperfectly competitive market for corporate control can exist when a target is worth more

to one bidder than the others, but no one is aware of this additional valueb. A firm has to possess valuable and rare links with bidding firms to gain economic profits and

competitive advantages from its acq strategies, but info about these special economies of scope

must not be know by other firms

i. If its known by other firms, those firms will try to duplicate the value themselvesD. Valuable, rare and costly-to-imitate economies of scope

a. If other bidders cannot imitate one bidders valuable and rare economies with targets, thencompetition in this market will be imperfect and equity holders will earn profits

b. Unexpected valuable economies of scope between bidding and target firmsi. The difference between the unexpected value of the acquisition and the price the

bidder paid is the profit for equity holders

c. Implications for bidding firm managersi. The rules for bidding managers

1. Search for valuable and rare economies of scopea. Over rules inter firm linkages

2. Keep information away from other biddersa. Avoid multiple bidders for one targetb. Some times illegal to hold information

i. When seeking to acquire publicly traded firms, potentialbidders must meet disclosure requirements

3. Keep information away from targets4. Avoid winning bidding wars5. Close the deal quickly6. Operate in thinly traded acquisition markets

a. Thinly traded markets: a market where there are only a small numberof buyers and sellers, where info about opportunities in this market

are not widely known, and where interests besides purely maximizing

the value of a firm can be important

b. In the context of mergers and acquisitions: markets where only a few(or one) firms are implementing acquisition strategies


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c. Highly fragmented industriesd. Implications for target firm managers

i. Rules for target firm managers1. Seek information from bidders2. Invite other bidders to join the bidding competition3.

Delay but do not stop the acquisition

Organizing to implement a merger or acquisition

A. Post merger integration and implementing a diversification strategya. Mergers and acquisitions designed to implement diversification

i. M-form structureii. Management controls and compensation policies that are similar to those used in a

diversification strategy

b. Mergers and acquisitions designed for vertical integrationi. U-form structureii. Target firms can remain somewhat autonomous or may be completely integrated

B. Special challenges in post merger integrationa. Operational, functional, strategic, and cultural differences between bidding and target firms

involved in a merger or acquisition are likely to be much greater than these same differences

between parts of a diversified or vertically integrated firm

i. Reason: separate histories, separate management philosophies, and separate strategiesb. Cultural differences are the largest challenge

i. High levels of integration require greater cultural blendingii. Cultural blending maybe a matter of:

1. Combining elements of both cultures2. Essentially replacing one culture with the other

iii. Integration may be very costly, often unanticipatediv. The ability to integrate efficiently may be a source of competitive advantage

c. Challenges are though of as an additional costC. Government policy

a. Governments may constrain ownership by foreign firmsb. Governments may restrict repatriation of profitsc. Government labor policy may limit a firms ability to apply management practices to target firms

D. Problems in achieving acquisition successa. Problems with integration difficulties

i. Melding two disparate corporate culturesii. Linking different financial and control systems

iii. Building effective working relationships (particularly when management styles differ)iv. Resolving problems regarding the status of the newly acquired firms executivesv. Loss of key personnel weakens the acquired firms capabilities and reduces its value

b. Problems with inadequate evaluation of the targeti. Due diligence

1. The process of evaluating a target firm for acquisitiona. Ineffective due diligence may result in paying an excessive premium

for the target company

2. Managers may be over confident in their abilities3. Bidding wars often override valuation


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4. Must entice shareholders to sell stock which often results in paying a premiumii. Evaluation requires examining:

1. Financing of the intended transaction2. Differences in culture between firms3. Tax consequences of the transaction4.

Actions necessary to meld the two workforces

Advantages and disadvantages of M&As

A. Advantagesa. Reducing competitionb. Getting access to proprietary products or servicesc. Gaining access to new products of servicesd. Gaining access to new products and marketse. Access to technical expertisef. Access to an established brand nameg. Economies of scaleh. Diversification of business risk

B. Disadvantagesa. Incompatibility of top managementb. Clash of corporate culturesc. Operational problemsd. Increased business complexitye. Loss of organizational flexibilityf. Antitrust implications

McKinsey 7S Model: Great Application fro M&As

A. Check list: synergies sough (strategy, systems, structure)a. Reduced fixed costsb. Increased market sharec. Cross-salesd. Greater economies of scalee. Lower taxesf. More efficient resource distribution

B. Psychological traits driving M&As (blinds spots?) skills, shared values, staff, stylea. Empire-buildingb. Hubrisc. Feard. Mimicry

C. Five types of strategic fit (strategy, systems, structure)a. Overcapacity M&Ab. Geographic roll-up M&Ac. Product or market extension M&Ad. M&A as R&De. Industry convergence M&A

D. Critical issues post-implementation (shared values, skills, staff, style)a. Incompatible corporate culturesb. Business as usualc. High executive turn over


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d. Neglect business at handE. Steps before the deal (strategy, systems, structure)

a. Begin by formulating a clear strategyb. Pre-access the dealc. Do your due diligenced.

Devise a workable plan

e. CommunicateF. Steps after the deal (all 7S)

a. Establish leadershipb. Manage culture and respect employees of merged/acquired companyc. Explore new growth opportunitiesd. Exploit early winse. Focus on the customer

j370 final notes

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