Strategic Management/

Business Policy

Power Point Set #6:

Corporate Strategy
 Corporate Level Strategy
Corporate-level strategy concerns the selection
and management of a mix of businesses competing
in several industries or product markets.

It is the way a company creates value through the

configuration and coordination of multi-market activities:

To add economic value, a corporate strategy should enable

a company, or one of its business units, to perform one or
more of the value creation functions at a lower cost, or
in a way which supports a differentiation
advantage.
 Understanding the Value Chain

Raw Materials

Ba
ck
w ar
d
In
te
gr
at
io Manufacturing Diversification
n

Fo
r wa
rd
In
te
gr
at
io
n Distribution
 Vertical Integration
Professor Oliver Williamson of University of California at
Berkeley has made clear that In order to avoid confusion on
the vertical coordination problem it is important for the
manager to separate two distinct issues:

Issue #1: What is the objective for vertical coordination?

Or put differently, what efficiencies, risk sharing, or market
power advantages are being sought?

Issue #2: What organizational form (e.g., vertical

contracts, equity joint ventures, mergers & acquisitions)
best achieves the desired objective(s)?
 Vertical Integration
Why vertically integrate?

Market Power (increase revenue)

Entry barriers
Down-stream price maintenance
Up-stream power over price

Efficiency (lower cost)

Specialized assets & the holdup problem
Protecting product quality
Improved scheduling
 Optimal Input Procurement

Spot Exchange
No
Substantial
specialized
investments
relative to Yes Complex contracting
contracting costs? environment relative to
costs of integration?

No Yes

Vertical
Contract Integration

Managerial Eco. - Rutgers University 6-13

Risks in undertaking cooperative
agreements or strategic alliances

 Adverse selection
 Partners misrepresent skills, ability and other
resources
 Moral Hazard
 Partners provide lower quality skills and
abilities than they had promised
 Holdup
 Partners exploit the transaction specific
investment made by others in the alliance
 Motivations For Diversification
Value Enhancing Motives:

Increase market power

• Multi-point competition
R&D and new product development
Developing New Competencies (Stretching)
Transferring Core Competencies (Leveraging)

• Utilizing excess capacity (e.g., in distribution)

• Economies of Scope
• Leveraging Brand-Name (e.g., Haagen-Dazs to chocolate
candy)
 Other Motivations For Diversification

Motivations that are “Value neutral”:

Diversification motivated by poor economic performance in current

businesses.

Motivations that “Devaluate”:

Agency problem
Managerial capitalism (“empire building”)
Maximize management compensation
Sales Growth maximization
• Professor William Baumol
 Diversification
Issue #1: When there is a reduction in managerial
(employment) risk, then there is upside and downside effects
for stockholders:

On the upside, managers will be more willing to learn firm-

specific skills that will improve the productivity and long-run
success of the company (to the benefit of
stockholders).

On the downside, top-level managers may have the

economic incentive to diversify to a point that is
detrimental to stockholders.
 Diversification
Issue #2: There may be no economic value to stockholders in
diversification moves since stockholders are free to diversify by
holding a portfolio of stocks. No one has shown that investors pay
a premium for diversified firms -- in fact, discounts are common.

A classic example is Kaiser Industries that was dissolved as a holding

company because its diversification apparently subtracted from its
economic value.

• Kaiser Industries main assets: (1) Kaiser Steel; (2) Kaiser Aluminum; and (3)
Kaiser Cement were independent companies and the stock of each
were publicly traded. Kaiser Industries was selling at a discount which
vanished when Kaiser Industries revealed its plan to sell its holdings.
 The BCG Matrix
High Cell 1: Stars Cell 2: Question Marks

Industry
Growth Rate

Low Cell 3: Cash Cows Cell 4: Dogs

High Low
Relative Market Share
 Mergers and Acquisitions
A merger is a strategy through which two firms agree to integrate
their operations on a relatively co-equal basis because they have
resources and capabilities that together may create a stronger
competitive advantage.

An acquisition is a strategy through which one firm buys a controlling

or 100 percent interest in another firm with the intent of using a core
competence more effectively by making the acquired firm a subsidiary
business within its portfolio.

• A takeover is a type of an acquisition strategy

wherein the target firm did not solicit the acquiring
firm’s bid.
Reasons for Problems in
Acquisitions Achieving Success
Increased Integration
market power difficulties

Overcome Inadequate
entry barriers evaluation of target

Cost of new Large or

product development extraordinary debt

Increased speed Inability to

to market Acquisitions achieve synergy

Lower risk Too much

compared to developing diversification
new products

Increased Managers overly

diversification focused on acquisitions

Avoid excessive
competition Too large
Ch7-3
 Attributes of Effective
Acquisitions
Attributes Results
Complementary Buying firms with assets that meet current
Assets or Resources needs to build competitiveness
Friendly Friendly deals make integration go more
Acquisitions smoothly
Careful Selection Deliberate evaluation and negotiations are
Process more likely to lead to easy integration and
building synergies
Maintain Financial Provide enough additional financial
Slack resources so that profitable projects would
not be foregone 20
 Sustainable Competitive Advantage
Trying to gain sustainable competitive advantage via
mergers and acquisitions puts us right up against the
“efficient market” wall:

If an industry is generally known to be

highly profitable, there will be many
firms bidding on the assets already in
the market. Generally the discounted
value of future cash flows will be
impounded in the price that the
acquirer pays. Thus, the acquirer is
expected to make only a competitive
rate of return on investment.
 Sustainable Competitive Advantage
And the situation may actually be
worse, given the phenomenon of
the winner’s curse.

The most optimistic bidder usually over-

estimates the true value of the firm:

• Quaker Oats, in late 1994, purchased

Snapple Beverage Company for
$1.7 billion. Many analysts calculated
that Quaker Oats paid about $1 billion
too much for Snapple. In 1997, Quaker
Oats sold Snapple for $300 million.
 Sustainable Competitive Advantage
Under what scenarios can the bidder do well?

Luck

Asymmetric Information
– This eliminates the competitive bidding premise
implicit in the “efficient market hypothesis”

Specific-synergies between the bidder

and the target.
– Once again this eliminates the competitive
bidding premise of the efficient market
hypothesis.