Chapter.7

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Chapter 7 Corporate Strategy

Polluter Harmony Ad: Peter & Janet's Story

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STRENGTHENING A COMPANY’S MARKET POSITION VIA ITS SCOPE OF OPERATIONS

Range of its activities

performed internally

Breadth of its product and

service offerings

Extent of its geographic

market presence and

mix of businesses

Size of its competitive footprint on its market or industry

Defining the Scope of the Firm’s Operations

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Key concepts for analysing firm scope

Economies of scope: cost economies from spreading costs of over multiple products Transaction costs: When the costs of administration are lower than the costs of transactions, the firm grows in size and scope. The costs of corporate complexity: impose limits to the firm’s growth in size and scope

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HORIZONTAL MERGER AND ACQUISITION STRATEGIES

♦  Merger ●  Is the combining of two

or more firms into a single corporate entity that often takes on a new name.

♦  Acquisition ●  Is a combination in

which one firm, the acquirer, purchases and absorbs the operations of another firm, the acquired.

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Benefits of Increasing Horizontal Scope

Increasing a firm’s horizontal scope strengthens its business and increases its profitability by: Improving the efficiency of its operations Heightening its product differentiation Reducing market rivalry Increasing the firm’s bargaining power over suppliers and buyers Enhancing its flexibility and dynamic capabilities

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Why Mergers and Acquisitions Sometimes Fail to Produce Anticipated Results

♦  Strategic Issues: ●  Cost savings may prove smaller than expected. ●  Gains in competitive capabilities take longer to realize or

never materialize at all.

♦  Organizational Issues ●  Corporate cultures, operating systems and management

styles fail to mesh due to resistance to change from organization members.

●  Loss of key employees at the acquired firm. ●  The managers overseeing the integration make mistakes

in melding the acquired firm into their own.

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Motives for diversification Growth: A powerful motive for managers—but growth without profitability does not create value for shareholders. Growth through acquisition a major destroyer of shareholder value

Risk spreading: Diversification tends to reduce fluctuations in profits; but this does not necessarily create value for shareholders

Value creation: For diversification to create shareholder value it must exploit some linkage (“synergy”) between the different businesses, e.g. by: •  Exploiting economies of scope •  Operating an efficient internal capability market •  Operating an internal labour market

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BUILDING SHAREHOLDER VALUE: THE ULTIMATE JUSTIFICATION FOR DIVERSIFYING

The industry attractiveness

test

The cost-of-entry test

The better-off test

Testing Whether a Diversification Move Will Add Long-Term Value for Shareholders

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Testing Whether Diversification Will Add Value for Shareholders

♦ The Attractiveness Test: ●  Are the industry’s returns on investment as

good or better than present business(es)? ♦ The Cost of Entry Test:

●  Is the cost of overcoming entry barriers so great that profitability is too long delayed?

♦ The Better-Off Test: ●  How much synergy will be gained by

diversifying into the industry?

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STRATEGIES FOR ENTERING NEW BUSINESSES

Acquisition Internal new venture (start-up) Joint venture

Diversifying into New Businesses

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Corporate Diversification

♦ Related Diversification

●  multiple lines of business are linked in a firm

♦ Unrelated Diversification

●  owns businesses in its portfolio that share few, if any, common attributes

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Andrew Stuart Luster is the great-grandson of cosmetics giant Max Factor, Sr. and an heir to the Max Factor cosmetics fortune.

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Economies of Scope Operational Econ. of Scope - Shared Core Competencies

Honda’s engines are used in automobiles, motorcycles, outboard boat motors, lawn mowers, generators, and power tools such as hedge and weed trimmers.

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Economies of Scope Financial Economies of Scope Internal capital allocation Risk reduction Tax advantages

John Carter on course to be biggest movie flop of all time

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Managerialism - managers of larger firms receive more compensation Managers push for conglomerates

Robert A. Eckert Chairman of the Board and Chief Executive Officer - Mattel, Inc. Compensation for 2009

Economies of Scope for Managers

Salary   $1,250,000.00    

Bonus   $0.00    

Restricted  stock  awards   $2,899,174.00    

All  other  compensaCon   $502,893.00    

OpCon  awards  $   $1,843,269.00    

Non-­‐equity  incenCve  plan  compensaCon  

$2,500,000.00    

Change  in  pension  value  and  nonqualified  deferred  compensaCon  earnings  

$2,435,248.00    

Total  CompensaCon   $11,430,584.00  

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Management Hubris 3 common outcomes of firms led by managers who cause the firm to become involved in acquisitions Firms led by managers with these unrealistic beliefs change, are acquired, or go bankrupt in the long run

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Sustainability of Diversification Rarity not rare as a strategy but may have specific conditions that make it difficult to imitate (costly or difficult to acquire)

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Types of Vertical Integration Strategies

Full Integration

Partial Integration

Tapered Integration

Vertical Integration Choices

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VERTICAL INTEGRATION STRATEGIES

♦ Vertically Integrated Firm ●  Is one that participates in multiple segments

or stages of an industry’s overall value chain.

♦ Vertical Integration Strategy ● Can expand the firm’s range of activities

backward into its sources of supply and/or forward toward end users of its products.

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Backwards Integration Towards Suppliers

♦  Integrating Backwards By: ●  Achieving the same scale

economies as outside suppliers—low-cost competitive advantage.

●  Matching or beating suppliers’ production efficiency—differentiation-based competitive advantage.

♦  Reasons for Integrating Backwards: ●  Reduction of supplier power ●  Reduction in costs of major inputs ●  Assurance of the supply and flow of

critical inputs ●  Protection of proprietary know-how

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Integrating Forward to Enhance Competitiveness

♦ Reasons for Integrating Forward: ●  To lower overall costs by increasing channel

activity efficiencies relative to competitors. ●  To increase bargaining power through control

of channel activities. ●  To gain better access to end users. ●  To strengthen and reinforce brand awareness. ●  To increase product differentiation.

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Weighing the Pros and Cons of Vertical Integration

♦  Can vertical integration enhance the performance of strategy-critical activities in ways that lower cost, build expertise, protect proprietary know-how, or increase differentiation?

♦  What is the impact of vertical integration on investment costs, flexibility and response times, and the administrative costs of coordinating operations across more vertical chain activities?

♦  How difficult it will be for the company to acquire the set of skills and capabilities needed to operate in another stage of the vertical chain.

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OUTSOURCING STRATEGIES: NARROWING THE SCOPE OF OPERATIONS

♦  Outsourcing ●  Involves farming out value chain activities to outside vendors.

♦  Outsource an Activity When It: ●  Can be performed better or more cheaply by outside specialists. ●  Is not crucial to achieving sustainable competitive advantage and

does not hollow out the firm’s core competencies. ●  Allows a firm to concentrate on its core business, leverage key

resources, and do even better what it does best.

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The Risks of Outsourcing Value Chain Activities

♦  Loss of control when monitoring, controlling, and coordinating activities of outside parties by means of contracts and arm’s-length transactions.

♦  Lack of incentives for outside parties to make investments specific to the needs of the outsourcing firm’s value chain.

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STRATEGIC ALLIANCES AND PARTNERSHIPS

♦ Strategic Alliance ●  Is a formal agreement between two or more

separate firms in which they agree to work cooperatively toward common objectives.

♦ Joint Venture ●  Is a type of strategic alliance in which the

partners set up an independent corporate entity that they own and control jointly, sharing in its revenues and expenses.

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Capturing the Benefits of Strategic Alliances

Picking a good partner

Being sensitive to cultural differences

Recognizing that the alliance must benefit both sides

Adjusting the agreement over time to fit new circumstances Structuring the

decision-making process for swift

actions

Ensuring both parties keep their

commitments

Strategic Alliance Factors

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Strategic Alliances Versus Outsourcing

♦ Key Advantages of Strategic Alliances: ●  The increased ability to exercise control

over the partners’ activities.

●  A greater commitment and willingness of the partners to make relationship-specific investments as opposed to arm’s-length outsourcing transactions.

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Managing the corporate portfolio: the BCG growth-share matrix