Corporate Level Strategy

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Corporate-Level Strategy

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Corporate-Level Strategy

• Focuses on building value by managing operations in multiple businesses

• Addresses two issues:– What businesses should a corporation participate

in– How can these businesses be managed so they

create “synergy”

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Topics to Discuss

• Diversification– Related vs. Unrelated

• Synergies• Types• How to achieve• Issues to consider

• Mergers, acquisitions, and other means of achieving diversification

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Diversification

• Diversification is the expansion of operations by entering new businesses or product lines

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Two Types of Diversification

• Related – Diversifying into similar, or adjacent, activities– Often seen when a company diversifies into a part

of the value chain

• Unrelated– Diversifying into activity that is unrelated to

existing business(es)

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Synergy

• The rationale for diversification is to achieve synergies– Otherwise, why diversify?

• If you get $5 of value out of something that you pay $5 for, you haven’t created value

• Diversification can (potentially) lead to value creation

• Synergies are the result of diversification

• We will define synergy as the measurable benefit of diversification– “Measurable” means that you can quantify the benefit in

dollars

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Two Generic Types of Synergies

• Cost savings– Most common synergy– Easiest to estimate– Examples: elimination of duplicate jobs, facilities,

etc.

• Revenue enhancements

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Impact of Diversification on Synergies

• The nature of synergies is affected by the type of diversification

• We will explore synergies in more detail under:– Related diversification– Unrelated diversification

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Related Diversification

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Related Diversification Synergies

• Related diversification can create two sources of synergy:

1. Sharing resources across businesses– Results primarily in cost reduction synergies

2. Enhanced market power due to greater scale /power– Can result in cost reductions

• e.g. improved ability to bargain with suppliers, which reduces costs

– Or, can result in enhanced revenue• e.g. improved pricing power with customers

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Cost Savings from Sharing of Resources … some Definitions

• Economies of scale: reduced unit costs that result by spreading (sharing) a resource across an increased quantity of existing products

• Economies of scope: reduced unit costs that result by spreading (sharing) a resource across a wider variety or greater number of products

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Examples of Sharing of Resources

• Shared order-processing systems (e.g. Amazon)– Books, electronic goods, home goods, etc.

• 3M competencies in adhesives leveraged across many industries and products

• Apple leverages its product design competency across personal computers, mobile devices, phones, music / entertainment

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Increased Market Power

1. Pooled negotiating power– Results from stronger bargaining position (at parent level)

relative to suppliers, customers or competitors

2. Vertical integration– An expansion of the firm by integrating either the preceding

or successive product processes• Backward integration: incorporate more processes

toward original source of raw materials• Forward integration: incorporate more processes

toward ultimate consumer

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Vertical Integration

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Benefits of Vertical Integration

• Results in secure supply of raw materials or distribution channel that can not be held hostage by market forces

• Protection and control over assets and services required to produce and deliver valuable products and services

• Access to new business opportunities and new forms of technology

• Simplified procurement and administrative procedures

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Risks of Vertical Integration

• Costs and expenses associated with increased overhead and capital expenditures

• Loss of flexibility resulting from large investments

• Problems associated with unbalanced capacities along the value chain

• Additional administrative costs associated with managing a more complex set of activities

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Summary: Related Diversification

• Synergies can take the form of: – Cost savings– Revenue enhancements

• Benefits (synergies) of related diversification can be created by:– Sharing of resources– Increased market power• Through larger size or vertical integration

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Unrelated Diversification

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Unrelated Diversification

• Unrelated diversification limits the opportunity to obtain synergies from– Sharing resources– Enhanced market power

• The synergies from unrelated diversification derive from different sources

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Unrelated Diversification

• Two main sources of synergy

1. Corporate office can contribute to:• “Parenting” (positive contributions as a result of support)• Restructuring of acquired businesses

2. Corporate office can manage businesses as a portfolio• Allocate resources to optimize corporate goals of

profitability, cash flow, and growth

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Restructuring

• Asset Restructuring– Sale of unproductive assets (or whole businesses); or possibly,

acquisitions that strengthen core business

• Capital Restructuring– Change of debt-equity mix, or mix between different classes of debt

or equity

• Management Restructuring– Change in composition of top management team, organizational

structure, reporting relationships– Tight financial controls, rewards based on achievement of short- or

medium-term goals

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Portfolio Management

• Three key aspects to portfolio management:– Assess competitive position of each business– Suggest strategic alternatives for each business– Allocate resources across the businesses

• Key purpose:– Achieve a balanced portfolio of businesses– That is, businesses whose profitability, growth,

and cash flow complement each other

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BCG Portfolio Matrix

Key

Each circle represents one of the firm’s business units

Size of circle represents the relative size of the business unit in terms of revenue

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Limitations of Portfolio Management

• Business units compared on only two dimensions

• Business units viewed as stand-alone entities• Process becomes largely mechanical• Reliance on “strict rules” regarding resource

allocation across SBU’s can be detrimental

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How Firms Accomplish Diversification

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Methods of Diversification

• Internal development / organic growth• Strategic alliances (cooperative relationship)• Joint ventures – more formal alliance created

when two firms contribute equity to a new legal entity

• Mergers and acquisitions

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Benefits of Mergers and Acquisitions

• Potential synergies– Cost savings– Revenue enhancements

• Can acquire critical technology, physical assets or know-how quickly

• Obtain resources needed to help expand it product offerings and services

• Can lead to consolidation within industry and can force other players to merge

• Means to enter new market segments

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Limitations of Mergers and Acquisitions

• The takeover premium paid for an acquisition is typically very high– Acquiring firm often pays a 30% or higher premium – Premium creates very high performance bar to justify cost

• Cultural issues often doom the intended benefits – Departure of key employees– Decline in productivity

• Competing firms can often imitate any advantages realized

• Manager’s credibility and ego can get in the way of sound business judgment

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Mergers and Acquisitions• A key analytic objective in a M&A situation is to identify synergies

– Cost reductions– Revenue enhancements

• Once synergies are estimated, the estimates can be used to help determine a purchase price for the target company

• Two main approaches to valuing a business:– Market comparables

• Price to earnings multiple (“P/E”)• Price to EBITDA multiple

– Discounted cash flow analysis (“DCF”)

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Affect of M&A on Employees

• Acquisitions or mergers can be a quick and efficient way to acquire:– Physical assets (factories, natural resources, etc.)– Systems, know-how, intellectual property

• But M&A are typically tough on employee morale• Minority stakes and joint ventures are sometimes

more effective when a key objective is to retain key managers of the target company

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Growth for Growth’s Sake

• Senior executives of larger firms:– Earn higher compensation– Enjoy more prestige– Have more job security

• There is “allure” to mergers and acquisitions– High visibility– Exciting– Ego plays a role

• Managerial motives can erode value creation