som final review

8/3/2019 SOM Final Review

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Chapter 8, Organizing to Implement Corporate DiversificationMonday & Wednesday, November 2 - 7, 2011

Teaching Notes & Outline

Point to Ponder: Dr. Drucker affirmed that Mission (drives) Structure (drives) Strategy.which ultimately(drives/infuses/influences) how the Implementation process flows [impacted].

Hard Question: What Is Organizing And Why Is It So Important? And, What Does Structure Have To Do With It, YouThink?!

In the previous chapter [we] discussed diversification and how firms expand to own multiple businesses in theirportfolio. We discovered that while embarking on diversification moves to maximize economies of scope is vital to havinga successful corporate strategy, a large diversified firm has to be managed and governed efficiently.

In other words, the businesses must be run on a day-to-day basis by competing in their product marketseffectively and creating corporate value by interacting with other businesses that the parent company owns. Employeesmust be organized into groups, reporting relationships established, resource allocation processes must be developed inshort, the company should be organized to function as a diversified organization.

Important Point: Its important to note scholars, that some of the issues examined in this discussion have application invertical integration, strategic alliances and mergers, and acquisitions.

Lil Known Fact! Historically, Alfred Sloan, the CEO of General Motors in the early 1900s, is regarded as the father of

the M-form (or the multidivisional form) structure. As GM grew exponentially and began diversifying its product line tomanufacture cars at different price points and aimed at specific target markets, Sloan realized that the traditionalfunctional or U-form structure was not effective. He came up with the idea of creating independent divisions (Chevrolet,Pontiac, Cadillac, etc.), all of which reported to a corporate office. The divisions had considerable autonomy (within setcorporate criteria) in making product-market decisions and were evaluated as independent profit centers. The idea of theM-form structure as the ideal way to manage large diversified firms was supported by the research of Alfred Chandler,who found that companies such as Sears and DuPont used this structure to expand.

Key Concepts: M-Form vs. U-Form Structure; Satisficing; Agency Relationships; Profit and Loss Centers; CorporateDiversification Strategy; Board of Directors; Principals & Agents; Institutional Owners; The Senior Executive; CorporateStaff; Division General Manager; Shared Activity Managers; Managerial Control Process; Management Compensation

Key Learning Points: To that end, let meintroduce the three fundamental issues firms face in implementing corporate

strategy. And, these issues become increasingly important as the firm becomes more complex. Lil Known FactThe morecomplex organization involving more people it becomes more difficult to align the interests of the firm and the people whowork in the firm.

Major Take-Always: As firms begin the process ofimplementing strategy, they confront three key issues: How should information flow within the organization Where and by whom are decisions made How to influence the behavior of people

Important Note: Now, let me introduce the concept of bounded rationality and Herbert Simons notion of satisficingdecisions. Satisficing means that people will make decisions that they think are good enough even though they cannotmake absolutely maximizing decisions because they are bounded in their rationality. The important implication here is

that as the information processing requirements faced by an individual manager grow beyond bounded rationality, themanager will continue to make decisions, but the quality of those decisions will decrease. Organizational structure helpsin this regard to make information processing more manageable.

Note: The important implication here scholars, is that as the information processing requirements faced by an individualmanager grow beyond bounded rationality, the manager will continue to make decisions, but the quality of those decisionswill decrease. Organizational structure helps in this regard to make information processing more manageable.

Important Point: Let me emphasize here the fact that information processing requirements grow with a firm. What theauthors mean by bounded rationality is that people have a limit on their capacity to handle information. Because peopleare bounded in their rationality, managers will satisficemake decisions that are good enoughin the face of growinginformation processing requirements. Organizational structure allows the information processing requirements of a firm to


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be divided up so that managers can operate effectively within their bounded rationality. Organizational structure isintended to increase the quality ofsatisficing decisions.

Key Learning Points:

I want to emphasize the importance of implementation to the success of any strategy effort.

I want to point out that information processing requirements become increasingly large andcomplex as organizations grow.

I want to note that strategy implementation is how large firms are able to handle the monumental

amount of information processing that is required in a large firm. I want to elaborate on the notions of bounded rationality and satisficing as elements necessitated by the

limits on managerial cognitive ability.

ORGANIZATIONAL STRUCTURE AND IMPLEMENTING CORPORATE DIVERSIFICATION

Learning Objective #1: Lets define the multidivisional, or M-form, structure and how it is used to implement a corporatediversification strategy.

In the M-form structure, each business that the firm engages in is managed through a division. For exampleunder CEO Jack Welch, General Electric was organized into 13 divisions where each business was evaluated separatelyand yet shared many resources with each other. Divisions in the M-form structure called strategic business unitsbusiness groups, orcompanies are true profit-and-loss centers, in that the corporate office calculates profits and losses

at the level of the division in these firms. Information is summarized and passed up through the organization throughthese replicated functions. Thus, the Senior Executive is able to handle the summarized information flowing from thedivisions. This is the hallmark of the M-form firm.

The advantage of the M-form structure is that each independent division can carve out its own destiny in itsproduct-market and focus on making decisions that best suit its specific competitive environment.

There is a tradeoff when we create a divisional structure between making information processing moremanageable and creating a separation of owners and managers. And, with this separation of owners and managerscomes the possibility that the interests of the two may diverge. This separation of owners and managers creates what isknown as the agency relationship.

The key to an effective agency relationship is for the interests of the two parties to be aligned. In other words, this

relationship will work as long as agents make decisions that further the interests of the equity holders.

Two common agency problems are:

investment in managerial perquisites, and managerial risk aversion.

Example: Perhaps the most egregious example of managers lavishing perquisites on themselves is Dennis Kozlowski oTyco International. For his wifes 40th birthday, Kozlowski rented a Greek island and threw a lavish party that cost thecompany millions. This was in addition to using company money to furnish his house with a $15,000 umbrella stand, a$6,000 wastebasket, etc.

Important Point: The M-form structure is designed to create checks and balances so that the interests of owners and

managers are aligned. One of these important checks is the monitoring role of the board of directors. By clearlydelineating the roles of each party involved in managing the organization, the M-form structure attempts to promotecongruent objectives.

Key Learning Point: The M-form structure provides a way for the interests of owners to be monitored. The board odirectors plays this monitoring role. Point out that institutional investors also play a monitoring role in many corporationstoday. Some institutional investors have board seats and are able to monitor through the board. Other institutionainvestors may still monitor the activities of managers very closely even if they do not hold seats on the board.

Hard Question: Who is [should be] this board, and, what is its role?! A companys board is elected by the firmsstockholders. The board role is to monitor the decision making of the managers and ensure that managers interests arealigned with those of the owners. In short, the board plays a key role in minimizing agency problems.


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A boards composition is a key issue. Why?! Board members can be internal or external. Internal boardmembers are top managers of the firm (typically the firms CEO, its CFO, and its COO) who serve on the board in additionto their regular duties. At board meetings, internal members convey to the board why they made a particular decisionThey bring valuable company and industry tenure and experience to these meetings. Outside board members do nowork for the company they are either CEOs or senior executives of other companies or are leading citizens in thecommunity. Ideally, of the 10-15 members in a typical board, the majority should be outsiders.

Boards have several important subcommittees, the finance committee (maintains the relationship between thefirm and external capital markets), the nominating committee (nominates new board members), and the personnel andcompensation committee (evaluates and compensates managers). It makes sense for these committees to be staffedentirely by outsiders. Outside board members are compensated for serving on the board.

The final key issue in company boards is the role of the chairman of the board. In many companies, the CEOserves as the chairman of the board. This dualresponsibility is the subject of much debate. The key is to strike the righbalance between the boards objectivity and its effectiveness in aligning the interests of owners and managers.

Institutional owners- They are usually pension funds, mutual funds, insurance companies, or others who own large blocksof shares in a company. Research reveals that, there has been a historical trend for a greater percentage of stock to beowned by institutional owners from 32 percent in 1970 to 59 percent in 2005. Institutional investors are not passiveinvestors because of their sizeable investment, they tend monitor the companys actions more closely and are oftenquite vocal in demanding changes.

One fearis that institutional investors may promote short-term performance measures instead oflong-term improvementsHowever, research has not supported this notion.The Senior Executive

Important Point: In an M-form structure, the senior executive is the only one likely to have the breadth of perspective toassess the entire portfolio of businesses owned by the company. Divisional managers know their divisions very well, butheir focus is too narrow. They may not know much about the other divisions owned by the company. Therefore, that thesenior executive MUST consult with the divisional managers to identify economies of scope that can be leveraged acrossthe portfolio.

The main functions of the senior executive are to:

formulate strategy, and implement strategy.

In large M-form firms these functions of the senior executive are often handled by dividing these responsibilitiesamong two or more people and referring to them collectively as the office of the president. Usually there are three mainroles in the office of the president:

1) the chair of the board of directorsmonitors management decisions2) the chief executive officerstrategy formulation3) the chief operating officerstrategy implementation

In some firms one person fulfills all these roles.

Important Point: People often move through these offices as a succession to the top or grooming process.

Note: As information flows up through the organization from the divisions there is a summarizing and filtering process sothe best and most necessary info for decision making goes to the next level. It is the executives who manage the flow oinformation and decision making in a firm. The important point is that information is filtered as it rises through theorganization. The quality of information flow influences the quality of decisions made based on that information.

Corporate staff report to the senior executive and provide advice on functional issues. The information provided by thecorporate staff helps the senior executive make important strategy formulation and strategy implementation decisions.


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Important Point: There is a difference between a direct, solid-line reporting relationship and an indirect, less formaldotted-line reporting relationship. Very often, this differentiation can cause conflicts in the organization. Divisional stafmanagers have a direct, solid-line reporting relationship with their respective corporate staff functional managers. Theyhave a less formal, dotted-line relationship with their division general manager.

The division general manager and the senior executive fill similar roles in that they both oversee several differenfunctions. The division general manager reports to the senior executive. Key point, the division managers are concernedprimarily with business level strategy whereas the senior executive is concerned primarily with corporate level strategy.

In addition to the two roles indicated above, division general managers have two specific responsibilities: to compete for corporate capital

to cooperate with other divisions to exploit corporate economies of scope.

Hard Question:What is the potential for conflict between these two specific responsibilities?!

Division general managers compete for resources with other divisions and cooperate with other divisions to exploieconomies of scope. This requirement of simultaneously competing and cooperating with other divisions very often putsan undue burden on the division general manager.

Shared Activity ManagersSome activities (functions) can be shared by two or more divisions in an M-form firm; and, this sharing creates an

economy. For example, a sales and marketing function shared by multiple divisions may be able to offer a higher level ofservice to all three than any one division could afford on its own. Note: shared activities can be treated as cost centers o

as profit centers.

Sharing activities helps exploit economies of scope. The cost of the activity is now borne by multiple businesses(or divisions). Activities that are typically shared include:

sales force research and development manufacturing distribution

MANAGEMENT CONTROLS AND IMPLEMENTING CORPORATE DIVERSIFICATIONLearning Objective #3: Lets discuss how the three management control processes measuringdivisional performance, allocating corporate capital, and transferring intermediate products are

used to help implement a corporate diversification strategy.

To this lets move the discussion away from structural issues to issues of management controls. While structure groupspeople, assigns tasks and establishes reporting relationships, controls are needed to monitorperformance.

Three important controls in the M-form structure are:o systems for evaluating divisional performanceo systems for allocating capital across divisionso systems for transferring intermediate products between divisions

COMPENSATION POLICIES AND IMPLEMENTING CORPORATE DIVERSIFICATIONLearning Objective #4: Lets describe the role of management compensation in helping to implement a corporatediversification strategy.

Example: Forbes.Coms Executive Compensation surveyThe highest compensated CEO in 2008 was Lawrence J. Ellison of Oracle who made a whopping $556.98 million.The average pay was $11.4 million. Forbes.com calculates an index termed efficiency. This is a ratio ofcompany stock performance to CEO pay. Ellison came in 103. The #1 CEO on the efficiency scale was MichaelBennett of Terra Industries, whose compensation was $10.47 million and #2 was amazon.coms Jeff Bezos whotook in a mere $1.28 million in compensation (forbes.com article dated 4/22/2009).

SUMMARY OF IMPLEMENTATION ISSUESIn closing, it is important for me to stress that implementation is when the rubber hits the road. The opportunity to exploieconomies of scope may be the driving force behind a firms diversification strategy. But economies of scope may only bea mirage unless the firm is organized to exploit it. Again, implementation consists of:


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organizational structure management control processes

compensation policies.Chapter 9, Strategic Alliance

Monday & Wednesday, November 9-14, 2011Teaching Notes & Outline

Lil Known Fact!o Its not about strategy. Its about execution of strategy.

o An alliance is an agreement or friendship between two or more parties, made in order to advance common goalsand to secure common interests.

o A business alliance is an agreement between businesses, usually motivated by cost reduction and improved

service for the customer. Alliances are often bounded by a single agreement with equitable risk and opportunityshare for all parties involved and are typically managed by an integrated project team.

o There are five basic categories or types of alliances:

Sales alliance Solution-specific alliance Geographic-specific alliance Investment alliance

Joint venture alliance

Sales alliance occurs when two companies agree to go to market together to sell complementary products and services.

Solution-specific alliance occurs when two companies agree to jointly develop and sell a specific marketplace solution.

Geographic-specific alliance is developed when two companies agree to jointly market or co-brand their products andservices in a specific geographic region.

Investment alliance occurs when two companies agree to join their funds for mutual investment.

Joint venture is an alliance that occurs when two or more companies agree to undertake economic activity togethero The North Atlantic Treaty Organization [NATO] or, also called the (North) Atlantic Alliance, is an

intergovernmental military alliance based on the North Atlantic Treaty which was signed on 4 April 1949. TheNATO headquarters are in Brussels, Belgium, and the organization constitutes a system of collective defensewhereby its member states agree to mutual defense in response to an attack by any external party

Setting the Learning Stage:What McDonalds and Disney have is a strategic alliance. A similar tie-in would be an alliance between (DreamWorks andBurger King or Visa and the NFL) to better help you understand what an alliance is (in broad terms) and howcommonplace they are, it is important to relate strategic alliances to the rest of Part 3 of the text. Strategic alliances are ameans of vertical integration and/or diversification and hence are part of corporate-level strategy. In this sense, they are amode of entry once a firm has made the decision to enter a new business.

What is a Strategic Alliance?The term strategic alliances is a broad one and includes any kind of cooperative effort between two or more independent

organizations. The effort may revolve around manufacturing or marketing or both.

Why would firms enter into strategic alliances?According to the authors, firms enter into strategic alliances because of two important motivations: to accesscomplementary resources and capabilities (that they do not have) and/or to leverage existing resources and capabilitiesThus, Disney has the capability to produce movies with compelling characters that children can identify with whileMcDonalds provides grassroots marketing. The notion of comparative advantage from international trade can be usedhere to explain the motivation for strategic alliances.

Different types of Strategic Alliances:When firms agree to work together to develop, manufacture, or sell products or services, they are engaged in a

nonequity alliance. The Disney-McDonalds alliance alluded to earlier is an example of a nonequity alliance. NeitheMcDonalds nor Disney invested in the equity of the other rather the two agreed to work with each other for a certain


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period of time. Such agreements could involving licensing (where one firm allows the use of its design or brand name toanother), supply agreements (agreeing to supply inputs), or distribution agreements (agreeing to sell another companysgoods).

When agreements to work with one another are supplemented with equity investments, equity alliances areformed. The Disney-Pixar alliance is an example. Back in 1986, Disney took a small equity position in Pixar as part of theterms of the strategic alliance. The alliance was prior to Disneys acquisition of Pixar in 2006.

A special form of equity alliance is a joint venture. Here, the cooperating companies (the parents) create alegally independent firm in which they invest and from which they share any profits created. For example, the twopharmaceutical companies, Johnson and Johnson and Merck created a joint venture (called Johnson and Johnson MerckConsumer Pharmaceuticals) to market over-the-counter pharmaceuticals such as Mylanta.

Important point:From the standpoint of the law, although the strategic alliance partners own the joint venture, courts have ruled that the

joint venture is a separate legal entity. When lawsuits were filed against Dow Corning in the silicone gel implancontroversy, courts held that claimants cannot include the parent companies in the lawsuit.

Teaching Points: Lets be mindful of how gains come from trade and comparative advantage ideas to and see

how alliances can create value under certain conditions. If a firm cannot identify a gain from trade from an alliance, the firm should not pursue tha

alliance I encourage you to reconsider the earlier examples of strategic alliances (such asDisney-McDonalds, Disney-Pixar) to better understand the different types of alliances.

Lets be mindful that including equity in an alliance arrangement is a way to align the interestsof the partners.

Alliances are a very popular means to implement a firms strategy, and particularly so, ininternational markets.

How do Strategic Alliances Create Value?The motivation to enter into a strategic alliance is value creation for the partners. How is value created in an alliance?Value is created in three broad ways:

Helping firms improve the performance of their current operations Creating a competitive environment favorable to superior performance Facilitating entry and exit

Lets think of these motivations as value creating opportunities. If sources of value creation and gains from trade cannobe identified in an alliance, then managers should be wary of entering into the alliance.

Strategic Alliance Opportunities:Economies of scale (described in chapter 2) exist when per unit cost of production falls as the volume of productionincreases. A single firm, for various reasons, may not have the scale to benefit from these economies. By combining withanother firm, the efficient scale can be reached.

Alliances may help improve operations because of learning opportunities. When firms work together, they canobserve each other and transfer skills across firms. Such interactions help in learning. General Motors wanted to learnlean production techniques. Toyota, on the other hand, wanted to learn to operate manufacturing plants in the U.S.particularly to adapt their famed production technology to U.S. workers.

Alliances are attractive when firms engage in projects that are expensive and where the risks are high. Bycombining forces, each firm reduces the downside risk if the project fails. Of course, this also means that the firms have toshare the profits generated by the project.

Alliance Threats: Incentives to Cheat on Strategic Alliances:Given the enormous benefits that firms can get by forming strategic alliances, as discussed in the previous section, whydo a large number of alliances fail? Clearly, alliances may fail because the value creating potential may have beenoverestimated to begin with. However, there is also a second possibility. Alliances may fail because an alliance partnecheats that is, not cooperate in a way that maximizes the value of the alliance.

One of the key challenges to a successful strategic alliance strategy is that partners often face strong incentives tomisappropriate the value created within an alliance. These challenges arise primarily because of the difficulties ofmonitoring the actions of other partners. Partners may take advantage of other partners at several points in an alliance


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relationship: in contributions to the alliance, in performance within the alliance, and in allocating the value created in thealliance.

Adverse Selection:Firms enter into alliances to pool resources and skills. What happens when a firm promises certain resources to thealliance partner but does not deliver? This situation is called adverse selection. In many cases, particularly involvingtangible resources, an alliance partner can determine exactly what its partner is bringing to the table. In suchobservable resource pooling, the possibility of adverse selection is minimized. If the resources that a potential partnehas are not attractive, then the firm seeking a partner can look for other partners that have these resources. But theproblem becomes much more challenging when the resources are intangible knowledge of markets, human capitalcontacts, etc. These are difficult to observe and so firms enter into the alliance hoping that the partner indeed has theseresources. When this is not true, the value creation potential of the alliance is constrained.

Moral Hazard:In the case of adverse selection, the partner does not have the resources that it promised to contribute to the allianceMoral hazard is when the partner has these resources but fails to make any or most of these resources available to thealliance partners. A partner may promise to send the best and brightest engineers to work in an alliance and then chooseto actually send only mediocre engineers to work in the alliance. In a sense, the difference between adverse selectionand moral hazard is this: adverse selection in an alliance is akin to an employee getting a job by falsely stating thahe/she has certain skills important to the job. Moral hazard is when the person has these skills but chooses not to usethem in the job.

Hold Up:Sometimes, the strategic alliance may call for one partner to make a transaction-specific investment. Transaction-specificinvestments introduce the possibility of holdup.

Strategic Alliances and Sustained Competitive Advantage:Strategic alliances can be sources of sustained competitive advantage. The VRIO framework can be used once again toexamine this contention. By exploiting one or more of the opportunities and avoiding the threats discussed earlieralliances create value. How about the other parts of the VRIO framework?

The Rarity of Strategic Alliances:Given the vast number of strategic alliances announced on a regular basis in the business press, it is clear that alliancesper se are not rare, even within an industry. However, it is not the creation of strategic alliances that should be looked at.Rather, what makes an alliance rare is the motivation to form the alliance and the type of resources that partners pool to

form the alliance. Look at this example: Lets say that several firms in an industry enter into independent strategicalliances. Imagine that only one firm enters into an alliance for learning purposes. It cooperates with another firm that hasvaluable resources to offer in the area of learning. This would make this alliance rare.

The Imitability of Strategic Alliances:Strategic alliances can be imitated by direct duplication or by substitution. When these avenues are not possible (in thathey dont create the same value), the alliance passes the costly-to-imitate test. Once again, alliances can be imitated bydirect duplication. If Firm A in an industry can form a marketing alliance, its competitor, Firm B can form a similar allianceThe test, though, is in combining the partners resources in such a way that value creation is maximized. Successfualliances are typically characterized by complex social relationships between the partners. There is usually a greatamount of trust and information exchange among the partners. This may be difficult to imitate by others. Some firms mayhave tremendous expertise in forming and managing alliances and may benefit from the learning curve. This may bedifficult for others to imitate.

Organizing to Implement Strategic Alliances:To maximize the value of a strategic alliance, it must be organized in a way that opportunities are exploited and threatsare avoided. The O in the VRIO framework, thus, is a very critical component of strategic alliance success. Manyalliances fail because of governance problems. It is a good idea for the instructor to first of all list the organizing options bydividing them into formal and informal categories. Formal options are: explicit contracts and legal sanctions; equityinvestments, and joint ventures. The informal ones are: trust and firm reputation.

Explicit Contract and Legal Sanctions:The threats that adversely affect the success of an alliance (adverse selection, moral hazard, and holdup) can beanticipated and the alliance contract can explicitly provide remedies for them. The contract can include legal sanctions fobreach of these provisions. Table 9.6 in the text provides a long list of provisions commonly found in strategic alliance


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agreements. If time permits, the instructor can go through some of these to illustrate how contract provisions can preventproblems between alliance partners.

Equity Investments:Equity investments increase the stake for firms involved in the alliance. Because Firm A has invested in the equity of FirmB as part of the alliance (called equity alliances), Firm A is not likely to cheat Firm B. If it does, then its equity in Firm Bloses value. Equity arrangements are particularly common among Japanese companies. These cross holdings (thenetwork is called a keiretsu) reduce the incentives for one firm to cheat the other for short-term gains.

Joint Ventures:Just as equity alliances minimize the possibility of cheating because of the financial impact to both firms, joint ventures area good organizational option for the same reason. Both firms have a financial interest in the joint venture. If one cheatsthe other, the joint venture suffers. Losses incurred by the joint venture affects the financials of both firms. Joint venturesare the preferred mode of alliances when the possibility of cheating is high.

Trust:Lets examine the issue oftrust and it importance to alliances. Research has indicated that the one characteristic that iscommon in most successful alliances appears to be a significant amount of trust placed by the partners in each otherBeyond contractual provisions, trust is what is likely to bind the two firms in a cooperative relationship and take care oeveryday problems that may surface. Firms that have a successful track record of alliances seem to excel in this areaResearch suggests that trust in an alliance can serve as a substitute for more formal governance mechanisms likecontracts. Even though almost every alliance has a contract the role of the contract in the alliance can vary a great deal

from being relied upon almost daily to never being referenced once it is signed. In those alliances where the contract isseldom looked to after the creation of the alliance, trusting relationships are relied upon to guide the behavior of partners.

Firm Reputation:If a firm seeks to use strategic alliances as a means to compete in its industry, needless to say, it should maintain areputation as a reliable partner. If it maximizes its value in a specific alliance through cheating, it is unlikely to findcompanies willing to partner with it in the future. It behooves a firm to maintain its reputation so as to not preclude thepossibility of forming alliances in the future. This threat that of a smeared reputation, is likely to have a greater effect, insome cases, that what is contractually written. However, the possibility of a tarnished reputation may not work to prevenopportunistic behavior in some cases. Obviously, subtle cheating is less likely to draw the same attention as overtcheating. Also, the information about a firm cheating must be made public in order for it to be a threat. Some firms maynot be well connected in a network to enable this. Finally, tarnished reputation (or the fear of it) may not help the affectedpartner in the current alliance. In short, this is not a panacea for alliance problems.

Teaching Points: Organizational choices for strategic alliances fall into two broad categories: formal and informal. Equity alliances and joint ventures are quite useful ways to ensure that firms do not cheat because there is a

financial issue involved. Joint ventures are useful when transaction-specific investment is required by one party. Subjective issues like reputation and trust are critically important in the management of alliances.

Summary:

Alliances are becoming increasingly popular as vehicles for a variety of strategic purposes. There are a number of waysby which alliances create value. However, it is important that a firm approach alliances using the VRIO lens. Allianceshave to create value, be rare and costly-to-imitate, and be organized in such a way that it achieves its purposeUnderstand that alliances are a form oforganizing economic exchange. These economic exchanges should producegains from trade. I encourage you to identify the resource combinations that form the basis for gains from trade in anyalliance. Furthermore, I encourage you be aware that simply identifying the gains from trade is not enough to ensurealliance success. The exchange must be managed in an appropriate way if the gains from trade are to be realized. Aswith other strategy concepts covered in the course, alliances require firm capabilities. Some firm will be better at creatingand managing alliances than others. I remind you that you I have shown you a way to analyze alliances that will allow youto draw well-informed conclusions as to whether or not an alliance will result in competitive advantage.


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Chapter 10, Mergers and AcquisitionsMonday & Wednesday, November 28-30, 2011


Lets Set the Learning Stage Reported n=450 wireless mergers in last 10 years

First 11 months in 2008, there were 8, 190 acquisitions/mergers in US

In 2007, the total value of announced mergers activities in the US was $1.7 trillion

Why Mergers and Acquisitions?Lil Known Fact:

Mergers and acquisitions (often referred to as M&A) help a firm implement a strategy of diversification or verticalintegration. In other words, while vertical integration and diversifications are corporate-level strategy options, M&A (alongwith strategic alliances and internal development) is a vehicle or mode of entry.

Hard Question: What would the role of the M&A activity look like in the strategic management process?! It is a mode of

entry into various businesses that a firm may want to enter as a part of the firms corporate level strategy. M&A activityshould satisfy the logic of corporate level strategy. Let me point out that I am not claiming that managers always adhereto this logic, but that as an element of corporate level strategy, M&A activity shouldsatisfy this logic.

What are Mergers and Acquisitions?

While the words are used interchangeably, they mean something different. Merger sounds less threatening andis often used in press releases in an effort to make a deal more attractive.

Acquisition is the purchase of a firm. The purchase does not have to be 100 percent ownership. It could be amajority ownership (greater than 51 percent of the acquired firms stock) or a controlling interest (enough stock ownershipto control management and strategic decisions at the acquired firm).

According to the authors, acquisitions can be friendly orunfriendly. In a friendly acquisition, the management o

the acquired firm wants the firm to be acquired. In an unfriendly acquisition (also called hostile takeovers), themanagement of the target firm does not want the firm to be acquired.

Now, lets look at the mechanics of M&A activity. For starters, we know that this activity is tightly regulated by the SEC.Key Learning Point: While a merger may start out as a transaction between equals, it may happen that in the course oftime, one firm dominates the other. The point is that a merger may end up looking like an acquisition in terms of which firmhas control.

Major Take-Aways: Mergers and acquisitions are extremely popular as evidenced by their coverage in the

business press. The M&A activity is a much-used vehicle particularly for a strategy of diversification.

Again, while the business press may use the terms mergers and acquisitionsinterchangeably, the two are different. Note the difference between a friendly acquisition and an unfriendly [give some

examples].

The M&A activity should create value for a firm according to the logic of corporate level strategy. Letsrecall the gains acquired from the trade concept from strategic alliances and to the notion of economies ofscope that reminds us about how this value might be created.

The Value of Mergers and Acquisitions

M&A activity presents an interesting question. M&A activity is a common occurrence in the corporate world andthe dollar values involved in these transactions amount to trillions. Yet, it is not clear that M&A activity actually generatesvalue for firms implementing these strategies.


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Note: An M&A strategy makes sense for a firm if the transaction creates value for the firm, whether it be the acquiringfirm or the acquired firm. Not all M&As create value.

Summary of Mergers and Acquisitions

It is important that we [you scholars] understand that M&A activity is a commonplace occurrence in the businessworld. On a regular basis they read about these transactions and some may have worked in an organization that wasinvolved in M&A activity.

One of the most important things to take away from this chapter is that M&A activity is part of a firms corporatelevel strategy. As such, M&A activity should generate value for the firm that stems from economies that shareholderscould not get by simply diversifying their individual portfolios.

The popularity of M&A activity runs contrary to the research on the value created by these transactions. Theessence of the research findings is that stockholders oftarget firms gain while those ofbidding firms do not. However, thepopularity of M&A activity is not so perplexing when the long term results of the strategy are considered. Remember, thathe outstanding long term results of Wells Fargo were the result of Wells Fargo pursuing an M&A strategy with attention todetail and spreading its core competencies to its targets.

Chapter 11, International StrategiesWednesday, December 8, 2011


What are International Strategies?

International Strategy Defined.

International strategy simply refers to the concept of operating in multiple countries simultaneously. A goodexample of a company implementing international strategies would be Procter and Gamble. The company operates inover80 countries (meaning it has either production facilities or sales offices) and sells its products in over 180 countriesThis helps us to better understand just how widespread the company is in terms of its global reach.

Hard Question:What is the relationship between International Strategy and other Corporate Strategies including [verticaintegration and diversification]?

According to the authors international strategy is just corporate strategy in a different geographical context. Thispiece provides the link between this chapter and the topics discussed in part 3 of the book corporate strategies such as

vertical integration, diversification, strategic alliances, and mergers and acquisitions. Therefore, why firms might want topursue corporate strategies in an international context are essentially the same reasons why firms pursue corporatestrategies

International strategies can be pursued by any kind of firm large, medium, or small. In addition, these strategiescan be pursued at any time in a companys life.


International strategies are extremely popular as evidenced by their coverage in thebusiness press. And, so we learn that international activity is a much-used vehicleparticularly for a strategy of diversification.

International strategies are not a recent development. They have been around for avery, very long time.


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Most major companies have diversified their revenue base by getting sales from several foreign markets. We can see how some seemingly U.S. companies get a substantial part of their revenues from abroad.

The Value of International StrategiesHard Question:

So, what do international strategies have to do with the VRIO framework? Let me reiterate that to be a source osustained competitive advantages for firms, international strategies must exploit a firms valuable, rare, and costly toimitate resources and capabilities. Not just that, but the firm must be organized in such a way that it can realize theadvantages of these resources and capabilities.

Key Learning Point:To Gain Access to New Customers for Current Products or Services

International strategy creates value if such a foray helps the firm gain access to new customers for its current producor service offerings. If customers in foreign markets are both willingand able to buy the firms products or services, then the firmcan increase its revenues in pursuing this option. The key question, then, is will the firms offerings sell in foreign markets?

This leads to the issue ofconvergence vs. divergence of tastes worldwide.

Different physical standards internationally (size, for example) Differences in tastes

These differences can be addressed by being sensitive to local market needs. A good example of this isMcDonalds sensitivity to Indian belief in the sacredness of the cow by eschewing beef-based burgers in its stores in thatcountry.

Once we address the issue of willingness, we can turn to ability to buy or affordability. A firm looking intointernational markets should realize that are at least three reasons local customers may be willing but unable to buy thefirms products:

Inadequate distribution channels Trade barriers Insufficient wealth to make purchases

Distribution is not organized in many foreign markets the same way it is in Western Europe or the U.S. Besides, firmsalready operating in these markets may control the distribution networks effectively locking out potential foreign entrantsIn addition, inadequate transportation, warehousing, and retail facilities may hinder entry into some foreign markets.

Table 11 presents a daunting list of tariffs, quotas, and nontariff trade barriers. Finally, foreign consumers maynot have the financial wherewithal to buy certain goods or services provided by foreign firms. Per capita GDP varieswidely among countries.

To Gain Access to Low-Cost Factors of Production

So far we have looked at the demand side of going international how to sell more of the product or the serviceLets defer our attention to the fact that supply side motivations are also valid reasons for going abroad. The three basicinputs that every firm needs raw materials, labor, and technology all may prompt firms to go international.

Accessing low-cost raw materials has historically been the motivation for international operations. Thus, coffeecompanies set up operations in coffee producing countries. Tropicana has operations in Brazil to access that countrysorange supply.

Labor costs vary across the world. The Made in China label has become quite ubiquitous in the Americaneconomy because of the low cost of labor in that country. Many companies have moved their call centers to countriessuch as India to take advantage of the availability of low cost English-speaking people in that country. There is a dark sideto this, however, as described in the Race to the Bottom ethics and Strategy box. For many people, low cost labor wouldconjure up images of sweat shops and inhumane working conditions.


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Maquiladoras, or manufacturing plants owned by foreign companies but operated in Mexico close to the U.S.border have become commonplace. Labor costs in Mexico are roughly one-fifths of those in the U.S., makingmaquiladoras highly attractive.

Access to foreign technology may also motivate firms to go abroad. This typically happens in the case ofcompanies from less technologically advanced countries setting up operations in countries with more advancedtechnologies.

To Develop New Core Competencies

A company may want to develop new competencies to help it compete in the global marketplace. This motivationmay prompt it to go international to either adapt its existing competencies to market conditions or to help develop newones. For this to happen, though, the organization has to have a learning orientation. Wal-Mart, for example, made anumber of mistakes in its international operations (it stocked its Mexican stores with snowmobiles, for example!), butlearnt from every one of them to have a sizeable international business.

Learning is critical to success in the international setting. On one level, firms have to learn about the new markebefore entering. For example, as suggested above firms need to learn which resources and capabilities may or may nomeet the VRIO criteria. On another level, firms must continue to learn after entering the new market. This is especiallytrue when firms have entered the new market with a partner. If the firm is attempting to acquire new resources andcapabilities, learning will obviously be critical to success.

Key Learning Point: A learning mentality not only helps the firm absorb knowledge in a new market, it also helps thefirm avoid costly overconfidence. Some firms commit costly cultural faux pas simply because they are too arrogant toinvest in learning about the local culture.

To Leverage Current Core Competencies in New Ways

International operations can also help firms use existing competencies in new product/market arenas. Doing thisallows the firm to exploit new opportunities that play to their existing strengths. The example given in the book of Hondasentry into the lawn mower business is a good one. Honda has core competencies in developing high performance powertrains. They used to create successful businesses in motor cycles and automobiles. The U.S. market, however, gavethem a new opportunity in lawn mowers that they did not have in Japan.

To Manage Corporate Risk

The topic of diversification to manage corporate risk was first visited in Chapter 7. The conclusion in that chaptewas that since outside shareholders can diversify their own investment portfolio in a more efficient way, corporatediversification for the sole purpose of risk reduction was a questionable motivation. The same holds true in the case ofdiversification in an international context, but for two exceptions.

Hard Question: If investor A wants to diversify his risks, can he invest in multiple domestic stocks? The answer to this isa yes.

Heres Why! It is quite easy for investor A to buy a number of domestic stocks to own a reduced risk diversified portfolioWhat if he wants to own stocks of foreign companies to reduce his exposure to one countrys stocks? This is not as easyas diversifying into domestic stocks. In certain cases, there are barriers to international capital flows. In such cases it ismore efficient for the firm to diversify internationally to reduce risks.

The second exception has to do with privately owned firms. Shareholders in such firms may continue to own the firmsstock for a variety of reasons and hence may not have the liquidity to diversify their investment. In such cases, it may be

justifiable for the firm to do so.


Let me underscore the importance of value creation as the key motivation behindinternational expansion.

Emphasize the need to look at motivations both from a revenue viewpoint (demand side)as well as from a cost viewpoint (supply side). In addition, learning and risk reduction arealso good motivations.


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Financial and Political Risks in Pursuing International Strategies

Financial Risks: Currency Fluctuation and Inflation

As firms do business in foreign markets, they may face currency fluctuations, different rates of inflation, differenaccounting practices and a host of similar financial risks.

Key Learning Point: Let me remind you thatwhile many financial risks exist in international markets, most risks arepredictable and therefore manageable. Firms hedge against currency fluctuations, for example. Very often the real risklies in sudden and unpredictable changes in the economic environment in the host country.

Political Risks

Lets discuss the political risks associated with international strategies and how they can be measured.

Just as the political environment forms an important part of the analysis in the firms domestic market, it affects afirms international strategies. The effect can be felt at the macro level, such as when a country becomes hostile to alforeign investment. Rapid political changes are a fact of life in many countries and foreign companies have to constantlybe aware of seismic shifts in governmental thinking. Political changes do not have to be to the disadvantage of foreignfirms. When faced with a severe foreign exchange shortage in 1991, the Indian government, at the behest of the World

Bank, opened up the country for foreign investment. The effect can also be felt at the micro or firm level as the followingexample illustrates.

Example: EDS Faces Political Risk in IranWhen the Shah of Iran was deposed in the late 1970s and fundamentalists took control of the countryEDS, the U.S. software firm founded by Ross Perot, was forced out and its assets were expropriatedThe company had been entrusted with the task of creating a social security system for Iran. When EDSdemanded payment for work done, the Iranian government responded by kidnapping a group of EDSexecutives. The Iranians demanded a ransom that was exactly equal to what EDS was demanding aspayment for services rendered! Ross Perot mounted a heroic rescue attempt to get his executives out othe country. This incident formed the basis of a made-for-television movie called On Wings of Eagles.

Summary of Issues in International Strategies

We now understand that international strategies are a special case of diversification strategies. In other words,these diversification strategies happen outside the firms domestic borders. This means that like any other diversification,international strategies must make sense from the point-of-view of economies of scope. On a regular basis some of youread about these transactions and some may be working in an organization that is involved in M&A activity.

One of the most important learning points is for you to understand is that as firms go international they are facedwith two opposite imperatives 1) to be locally responsive or 2) go for economies of scale via international integration.

The VRIO framework allows us to see if a firms international strategy is a source of sustained competitiveadvantage. While international strategies are commonplace in todays world, a firm can bring unique resources andcapabilities to international markets. This not only makes it rare, it also makes direct imitation difficult and costly. Thereare, however, substitutes in the form of strategic alliances and wholly owned subsidiaries.Firms must organize themselves to take advantage of international opportunities. They have several options to do sobut the option must match their strategy of eitherlocal responsiveness orinternational integration.


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som final review

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