Management
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Professor Ranfeng Qiu
Strategic Management
Session 9
MGMT 490
Professor Ranfeng Qiu
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Studying this chapter should provide you with
the strategic management knowledge needed to:
Learning Objectives
Define corporate-level strategy and discuss its purpose.
Describe different levels of diversification achieved using different corporate-level strategies.
Explain three primary reasons firms diversify.
Describe how firms can create value by using a related diversification strategy.
Discuss the incentives and resources that encourage diversification.
Describe motives that can encourage managers to overdiversify
a firm.
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Professor Ranfeng Qiu
Professor Ranfeng Qiu
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Studying this chapter should provide you with
the strategic management knowledge needed to:
Learning Objectives (cont.)
Explain the popularity of merger and acquisition strategies in firms competing in the global economy.
Discuss reasons why firms use an acquisition strategy to achieve strategic competitiveness.
Describe seven problems that work against achieving success when using an acquisition strategy.
Name and describe the attributes of effective acquisitions.
Define the restructuring strategy and distinguish among its common forms.
Explain the short- and long-term outcomes of the different types of restructuring strategies.
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Corporate-level strategy I – Diversification strategy
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Business-level and corporate-level strategy
A group of different businesses competing in different product markets
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Two Strategy Levels
- Business-level Strategy (Competitive)
Each business unit in a diversified firm chooses a business-level strategy as its means of competing in its individual product markets.
- Corporate-level Strategy (Companywide)
Specifies actions taken by the firm to gain a competitive advantage by selecting and managing a group of different businesses competing in different product markets.
What businesses should the firm be in?
How should the corporate office manage the group of businesses?
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Diversification strategies play a major role in the behavior of large firms.
Product diversification concerns:
The scope of the industries and markets in which the firm competes.
How managers buy, create and sell different businesses to match skills and strengths with opportunities presented to the firm.
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Diversification
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- The scope of the markets and industries in which the firm competes
- Managers buy, sell and create different businesses.
- Diversified firms:
Levels of diversification
low, moderate and high
Connection (linkages) among business units
Operational
Business
Diversification Strategy
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Levels of Diversification: Low Level
Dominant Business
Between 70% and 95% of revenue comes from a single business.
Single Business
More than 95% of revenue comes from a single business.
61% from U.S. package delivery operations, 22% from international package delivery, and 17% from non-packaging operations.
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A
A
B
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- Related Constrained
Less than 70% of revenue comes from a single business and all businesses share product, technological and distribution linkages.
- Related Linked (mixed related and unrelated)
Less than 70% of revenue comes from the dominant business, and there are only limited links between businesses.
Levels of Diversification:
Moderate to High
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A
B
C
A
B
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Corporate Executive Office
Chairman & CEO
Corporate Staff
Finance Business R&D Human Legal
Development Resources
GE Aircraft
Engines
GE Trans-
portation
GE
Industrial
Systems
GE
Plastics
GE
Appliances
GE
Supply
GE Power
Systems
GE Medical
Systems
GE
Lighting
GE
Specialty
Materials
NBC
GE
Capital
26 businesses organized into 5 segments:
Consumer Mid-market Specialized Specialty Equipment
Services Financing Financing Insurance Management
Service Divisions
General Electric’s Organization Structure, 2002
Service Divisions
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Levels of Diversification:
Very High Levels
- Unrelated Diversification
Less than 70% of revenue comes from the dominant business, and there are no common links between businesses.
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B
A
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Figure 6.1 Levels and Types of Diversification
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Levels and Types of Diversification
relatedness
diversification
Single
Dominant
Related-constraint
Related-linked
Unrelated
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Table 6.1 Reasons for Diversification
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| Value-Creating Diversification | Value-Neutral Diversification | Value-Reducing Diversification |
| Economies of scope (related diversification) Sharing activities Transferring core competencies Market power (related diversification) Blocking competitors through multipoint competition Vertical integration Financial economies (unrelated diversification) Efficient internal capital allocation Business restructuring | Antitrust regulation Tax laws Low performance Uncertain future cash flows Risk reduction for firm Tangible resources Intangible resources | Diversifying managerial employment risk Increasing managerial compensation |
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High
Low
Value-Creating Strategies
of Diversification
Operational and Corporate Relatedness
Corporate Relatedness: Transferring Skills into Businesses through Corporate Headquarters
Operational Relatedness: Sharing Activities between Businesses
High
Low
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Related Constrained
Diversification
Vertical Integration
(Market Power)
Unrelated
Diversification
(Financial Economies)
Related Linked
Diversification
(Economies of Scope)
Both Operational and Corporate Relatedness
(Rare capability that creates diseconomies of scope)
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Reason for diversification
- Economies of scope
1. Operational Relatedness:
Share primary or support activities (in value chain)
mainly based on tangible assets
2. Corporate Relatedness:
managerial and technological knowledge
experience and expertise (intangible resources)
Value creation
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business and knowledge transfer reduce cost
Intangible resources difficult for competitors to understand and imitate
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Outbound logistics
manufacturing
Inbound
Logistics
Procurement
Distribution & sales
HRM, accounting and finance
Infrastructure
Paper Towel
Disposable diaper
P&G’s Diversification
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- Market Power (integration)
- Save on operations
- Product quality
- Protecting technology
- Avoid transaction costs
- More efficient suppliers
- Controlling integrated activities
- Technological opportunities
+
-
Reason for diversification
Sell products above the existing competitive level; or
reduce costs below the competitive level; or
both.
Horizontal
Vertical
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- Financial economies
Improved allocations of financial resources through internal investments
- Capital Market Allocation
Internal capital market
External capital market
- Information asymmetry
- Which market more efficient??
Internal capital market allocations
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Efficient Internal Capital Market Allocation
Corporate office distributes capital to business divisions to create value for overall company.
Corporate office gains access to information about those businesses’ actual and prospective performance.
Conglomerate life cycles are fairly short life cycle because financial economies are more easily duplicated by competitors than are gains from operational and corporate relatedness.
Restructuring creates financial economies
A firm creates value by buying and selling other firms’ assets in the external market.
Resource allocation decisions may become complex, so success often requires:
Focus on mature, low-technology businesses.
Focus on businesses not reliant on a client orientation.
External Incentives to Diversify
Antitrust laws in 1960s and 1970s discouraged mergers that created increased market power (vertical or horizontal integration.
Mergers in the 1960s and 1970s thus tended to be unrelated.
Relaxation of antitrust enforcement results in more and larger horizontal mergers.
Early 2000: antitrust concerns seem to be emerging and mergers now more closely scrutinized.
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Anti-trust Legislation
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External Incentives to Diversify (cont’d)
High tax rates on dividends cause
a corporate shift from dividends to buying and building companies in high-performance industries.
1986 Tax Reform Act
Reduced individual ordinary income tax rate from 50 to 28 percent.
Treated capital gains as ordinary income.
Created incentive for shareholders to prefer dividends to acquisition investments.
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Anti-trust Legislation
Tax Laws
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Internal Incentives to Diversify
High performance eliminates the need for greater diversification.
Low performance acts as incentive for diversification.
Firms plagued by poor performance often take higher risks (diversification is risky).
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Low Performance
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Internal Incentives to Diversify (cont’d)
Diversification may be defensive strategy if:
Product line matures.
Product line is threatened.
Firm is small and is in mature or maturing industry.
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Low Performance
Uncertain Future Cash Flows
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Internal Incentives to Diversify (cont’d)
Synergy exists when the value created by businesses working together exceeds the value created by them working independently
… but synergy creates joint interdependence between business units.
A firm may become risk averse and constrain its level of activity sharing.
A firm may reduce level of technological change by operating in more certain environments.
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Low Performance
Uncertain Future Cash Flows
Synergy and Firm Risk Reduction
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Resources and Diversification
- A firm must have both:
Incentives to diversify
The resources required to create value through diversification—cash and tangible resources (e.g., plant and equipment)
- Value creation is determined more by appropriate use of resources than by incentives to diversify.
- Strategic competitiveness is improved when the level of diversification is appropriate for the level of available resources.
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Value-Reducing Diversification:
Managerial Motives to Diversify
- Managerial motives to diversify:
Managerial risk reduction
Desire for increased compensation
Build personal performance reputation
- Effects of inadequate internal firm governance
Diversification fails to earn even average returns
Threat of hostile takeover
Self-interest actions of entrenched management
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Diversification and Performance
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Starbucks Diversification
“We will have other products with our name on it and no coffee in it"
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Corporate-level strategy II – Merger & Acquisition strategy
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Mergers, Acquisitions, and Takeovers:
What are the Differences?
- Merger
Two firms agree to integrate their operations
on a relatively co-equal basis.
- Acquisition
One firm buys a controlling, or 100% interest in another firm with the intent of making the acquired firm a subsidiary business within its portfolio.
- Takeover
An acquisition in which the target firm did not solicit the acquiring firm’s bid for outright ownership.
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Reasons for Acquisitions
Learning and
developing
new capabilities
Reshaping firm’s
competitive scope
Increased
diversification
Lower risk than
developing new
products
Cost of new
product
development
Overcoming
entry barriers
Increase speed
to market
Increased
market power
Making an
Acquisition
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Acquisitions: Increased Market Power
- Factors increase market power when:
There is the ability to sell goods or services above competitive levels.
Costs of primary or support activities are below those of competitors.
A firm’s size, resources and capabilities gives it a superior ability to compete.
- Acquisitions intended to increase market power are subject to:
Regulatory review
Analysis by financial markets
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Acquisitions: Increased Market Power (cont’d)
- Market power is increased by:
Horizontal acquisitions of other firms in the same industry
Vertical acquisitions of suppliers or distributors of the acquiring firm
Related acquisitions of firms in related industries
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Market Power Acquisitions
Acquisition of a firm in the same industry in which the acquiring firm competes increases a firm’s market power by exploiting:
Cost-based synergies
Revenue-based synergies
Acquisitions with similar characteristics result in higher performance than those with dissimilar characteristics.
Horizontal Acquisitions
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Market Power Acquisitions (cont’d)
Acquisition of a supplier or distributor of one or more of the firm’s goods or services
Increases a firm’s market power by controlling additional parts of the value chain.
Horizontal Acquisitions
Vertical Acquisitions
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Market Power Acquisitions (cont’d)
Acquisition of a firm in a highly related industry
Because of the difficulty in attaining synergy, related acquisitions are often difficult to implement.
Horizontal Acquisitions
Vertical Acquisitions
Related Acquisitions
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Overcoming Entry Barriers
- Entry Barriers
Factors associated with the market or with the firms operating in it that increase the expense and difficulty for new firms in gaining immediate market access.
Economies of scale
Differentiated products
- Cross-Border Acquisitions
Acquisitions made between firms with headquarters in different countries
Are often made to overcome entry barriers.
Can be difficult to negotiate and operate because of the differences in foreign cultures.
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Cost of New-Product Development
and Increased Speed to Market
- Internal development of new products is often perceived as a high-risk activity.
Acquisitions allow a firm to gain access to new and current products that are new to the firm.
Returns are more predictable because of the acquired firms’ past experience with its products.
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Lower Risk Compared
to Developing New Products
- An acquisition’s outcomes can be estimated more easily and accurately than the outcomes of an internal product development process.
Managers may view acquisitions as lowering risk associated with internal ventures and R&D investments.
Acquisitions may discourage or suppress innovation.
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Increased Diversification
- Using acquisitions to diversify a firm is the quickest and easiest way to change its portfolio of businesses.
- Both related diversification and unrelated diversification strategies can be implemented through acquisitions.
- The more related the acquired firm is to the acquiring firm, the greater is the probability that the acquisition will be successful.
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Reshaping the Firm’s
Competitive Scope
- An acquisition can:
Reduce the negative effect of an intense rivalry on a firm’s financial performance.
Reduce a firm’s dependence on one or more products or markets.
- Reducing a firm’s dependence on specific markets alters the firm’s competitive scope.
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Learning and Developing
New Capabilities
- An acquiring firm can gain capabilities that
the firm does not currently possess:
Special technological capability
A broader knowledge base
Reduced inertia
- Firms should acquire other firms with different but related and complementary capabilities in order to build their own knowledge base.
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Problems in Achieving Acquisition Success
Too large
Managers
overly focused on
acquisitions
Extraordinary debt
Inadequate
target evaluation
Too much
diversification
Inability to
achieve synergy
Integration
difficulties
Problems
with
Acquisitions
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Problems: Integration Difficulties
- Integration challenges include:
Melding two disparate corporate cultures
Linking different financial and control systems
Building effective working relationships (particularly when management styles differ)
Resolving problems regarding the status of the newly acquired firm’s executives
Loss of key personnel weakens the acquired firm’s capabilities and reduces its value
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Problems in Achieving Acquisition Success: Inadequate Evaluation of Target
- Due Diligence
The process of evaluating a target firm for acquisition
Ineffective due diligence may result in paying an excessive premium for the target company.
- Evaluation requires examining:
Financing of the intended transaction
Differences in culture between the firms
Tax consequences of the transaction
Actions necessary to meld the two workforces
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Problems in Achieving Acquisition Success: Large or Extraordinary Debt
- High debt (e.g., junk bonds) can:
Increase the likelihood of bankruptcy
Lead to a downgrade of the firm’s credit rating
Preclude investment in activities that contribute to the firm’s long-term success such as:
Research and development
Human resource training
Marketing
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Problems in Achieving Acquisition Success: Inability to Achieve Synergy
- Synergy
When assets are worth more when used in conjunction with each other than when they are used separately.
Firms experience transaction costs when they use acquisition strategies to create synergy.
Firms tend to underestimate indirect costs when evaluating a potential acquisition.
Advantage: It is difficult for competitors to understand and imitate.
Disadvantage: It is also difficult to create.
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Problems in Achieving Acquisition Success: Too Much Diversification
- Diversified firms must process more information of greater diversity.
Increased operational scope created by diversification may cause managers to rely too much on financial rather than strategic controls to evaluate business units’ performances.
Strategic focus shifts to short-term performance.
Acquisitions may become substitutes for innovation.
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Problems in Achieving Acquisition Success: Managers Overly Focused on Acquisitions
- Managers invest substantial time and energy in acquisition strategies in:
Searching for viable acquisition candidates.
Completing effective due-diligence processes.
Preparing for negotiations.
Managing the integration process after
the acquisition is completed.
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Problems in Achieving Acquisition Success: Managers of Target Firms
- Managers in target firms
May begin to operate in a state of virtual suspended animation during an acquisition.
May become hesitant to make decisions with long-term consequences until negotiations have been completed.
May develop a short-term operating perspective and a greater aversion to risk.
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Table 7.1 Attributes of Successful Acquisitions
| Attributes | Results |
| Acquired firm has assets or resources that are complementary to the acquiring firm’s core business | High probability of synergy and competitive advantage by maintaining strengths |
| Acquisition is friendly | Faster and more effective integration and possibly lower premiums |
| Acquiring firm conducts effective due diligence to select target firms and evaluate the target firm’s health (financial, cultural, and human resources) | Firms with strongest complementarities are acquired and overpayment is avoided |
| Acquiring firm has financial slack (cash or a favorable debt (position) | Financing (debt or equity) is easier and less costly to obtain |
| Merged firm maintains low to moderate debt position | Lower financing cost, lower risk (e.g., of bankruptcy), and avoidance of trade-offs that are associated with high debt |
| Acquiring firm has sustained and consistent emphasis on R&D and innovation | Maintain long-term competitive advantage in markets |
| Acquiring firm manages change well and is flexible and adaptable | Faster and more effective integration facilitates achievement of synergy |
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Restructuring
- A strategy through which a firm changes its set of businesses or financial structure.
Failure of an acquisition strategy often precedes a restructuring strategy.
Restructuring may occur because of changes in the external or internal environments.
- Restructuring strategies:
Downsizing
Downscoping
Leveraged buyouts
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Downsizing and downscoping
- Downsizing is a reduction in the number of a firm’s employees and sometimes in the number of its operating units.
May or may not change the the firm’s portfolio.
- Typical reasons :
Expectation of improved profitability from cost reductions
Desire or necessity for more efficient operations
- Downscoping is a divestiture, spin-off or other means of eliminating businesses unrelated to a firm’s core businesses.
May be accompanied by downsizing, but not the elimination of key employees from its primary businesses.
Results in a smaller firm that can be more effectively managed by the top management team.
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Leveraged Buyout (LBO)
- A restructuring strategy whereby a party buys all of a firm’s assets in order to take the firm private.
Significant amounts of debt may be incurred to finance the buyout, followed by an immediate sale of non-core assets to pare down debt.
- Can correct for managerial mistakes
Managers making decisions that serve their own interests rather than those of shareholders.
- Can facilitate entrepreneurial efforts and strategic growth.
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Figure 7.2 Strategic Positioning of Private Equity Firm
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Figure 7.3 Restructuring and Outcomes
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