J370 Final Notes Article: Structure is not organization I. I.

Paying attention provides a stimulus to productivity, more so that formal rewards The 7-S Framework a. Key insights i. Not just strategy and structure 5 other important factors ii. Mutual interdependency iii. Failure can be attributed to one or any combination iv. Circle emphasizes the absence of hierarchy v. Focus on qualitative factors vi. More holistic, less environmental b. Strengths i. Very comprehensive ii. Focus internally iii. Must mange both hard and soft aspects iv. Coordinate tasks v. Firm as a social system c. Weaknesses i. May miss the fine-grained areas ii. Difficult to assess iii. Little empirical support iv. How to implement v. Very static unless used intermittently d. About i. To perform well, all the elements must be aligned and be mutually reinforcing ii. Organizational elements are inter-related iii. Hard elements: can directly influence 1. Structure 2. Strategy 3. Systems iv. Soft elements: less tangible 1. Skills 2. Shared values 3. Staff 4. style A. Structure a. Divides tasks then provides coordination; trades off specialization and integration; it decentralizes then recentralizes b. Way in which tasks and people are specialized and divided, and authority is distributed c. Basic grouping of activities and reporting relationships into organizational sub-units d. Mechanisms by which the activities of the members of the organization are coordinated B. Strategy a. Direction and scope of the firm through which competitive advantage will be achieved C. Systems

a.

Formal and informal process and procedures used to manage the organization, including the management control systems, performance measurement and reward systems, planning, budgeting and resource allocation systems, information systems, and distribution systems Leadership style of top management and the over all operating style of the organization Style impacts the norms people follow and how they work and interact with each other and with customers People, their backgrounds and their competencies Organizations approaches to recruitment, selection, and socialization How people are developed; how recruiters are trained, socialized, and integrated; and how their careers are managed

D. Style a. b. E. Staff a. b. c. Skills a.

F.

Distinctive capabilities and competencies that reside in the organization and are what the organization does best b. Typically distinctive competencies of people, but can also include management practices, systems, and/or technology G. Super-ordinate goals a. The core or fundamental set of values that are widely shared in the organization and serve as guiding principles of what is important b. Usually communicated in simple ways, and may even seem trivial from the outside c. But to the organizations members, values have great meaning because they help focus attention and provide a broader sense of purpose Managing Knowledge II. What is the value of intellectual Capital A. Intellectual capital: knowledge that can be stored for use later B. Knowledge: information that can be connected to intention C. According to professor Quinn, information is the source of 75% of value-added in manufacturing firms III. Why is knowledge an increasingly important source of sustainable advantage? A. The global economy is becoming a knowledge-based economy B. Knowledge is a competitive advantage if it is unique and valuable a. Many observers are arguing that knowledge is the most likely resource to be unique and therefore the most likely to create sustained advantage C. Knowledge is the result of a learning process a. Knowledge management focuses on connecting all four parts of the learning process which are required to pass the benefit from one individuals learning to others b. When this is accomplished, the value of individual learning and collective learning increase with use i. opposed to most assets whose value diminishes with use ii. knowledge has been said to appreciate at every stage in the value chain 1. concrete experience 2. observation and reflection 3. forming abstract concepts 4. testing in new situations

a. b.

this is the learning process 1 and 2 are guaranteed to happen, however 3 and 4 are not

D. Human Capital theory a. Examines the role of the individuals competence, focusing on how an individuals knowledge enhances cognitive abilities and can result in more effective activities b. Considers how knowledge is developed and used at the individual level c. Knowledge is the only asset that can help a firm adapt to radical change as markets shift, uncertainty dominates, and technologies proliferate i. The firms that succeed in these difficult, sometimes hypercompetitive environments are able to create and disseminate new knowledge quickly and embody knowledge in their products and services E. Knowledge-based systems and processes have the greatest promise for long-term growth IV. What are the characteristics of knowledge needed by companies? A. Hierarchy of knowledge, information, and data a. Knowing how to use information is what makes knowledge a resource b. Knowledge: uses information to support direction or intent; created when strategists use information to do something c. Information: data connected with a connect that enables insight, analysis and conversation d. Data: raw input to knowledge; background, rarely valuable in and of themselves (i.e. facts, numbers) e. Most of the costs to develop and distribute knowledge is in the creation process i. Once knowledge is created, initial development costs can be spread across rising volume, and advantages from use can endure over time ii. Knowledge is an asset that can become more valuable as more people use it and add to it f. It is difficult to determine who owns knowledge i. Intellectual property rights: are knowledge resources that can be legally protected and thus potentially used for competitive advantage g. Valuable knowledge tends to be private and tacit B. Public vs. Private Knowledge a. Public knowledge: is openly available and not the unique property of any one firm i. Best practices: methodologies or techniques that have, through research and experience, been proven to lead to desired results 1. Necessary for survival in a highly competitive marketplace ii. Promising practices: alternative label for best practices that emphasizes the importance of adaptation to local circumstances iii. Widely available knowledge is not a source of competitive advantage unless the company figures out a different way to use that knowledge or applies it more faithfully than competitors iv. Failure to apply public knowledge can be a source of competitive disadvantage b. Private knowledge: can be protected form others, and includes a firms unique routines, processes, documentation, and trade secrets i. Only private knowledge can be a source of competitive advantage C. Explicit vs. Tacit knowledge a. Explicit: based on objective information and observable skills that can be easily taught or written down

b. Tacit: developed through experience and depends on an individual or group insight and intuition; more difficult to transfer to others and requires interactive experience i. Though more difficult to strategically manage, tacit knowledge can be the most valuable knowledge to a company because it can create a sustained competitive advantage D. Human Capital and Social Capital a. Human capital: role of individuals competence (education, on the job experience) b. Social Capital: individuals position in a social network of relationships and the resources embedded in, available through, or derived from these networks V. How do strategists manage and use knowledge? a. Taking the new learning of employees and making it available to others in the organization is the central activity of the knowledge-creating company i. Requires finding methods to combine traditional resources and capabilities in new and unique ways ii. An organizations ability to acquire, integrate, share and apply knowledge becomes to most important strategic resource for creating a sustainable competitive advantage b. Organizations need to develop a formal knowledge management process i. Indentifying what information a company has and developing approaches to make useful information available to organization members A. Knowledge creation a. The organization cannot create knowledge without individuals i. The organization provides the structure and support for individuals to create knowledge b. Socialization: (tacit tacit) i. describes the experience-sharing process of conveying tacit knowledge from one person to another, whereby a more experienced individual communicates mental models, technical skills, and other tacit knowledge 1. Occurs through dialogue, observation, imitation, and practice ii. New knowledge can result when an individual obtains information from another person, and this triggers an entirely new idea iii. As firms interact more with their customers, a socialization process is occurring c. Externalization: (tacit explicit) i. Defined as the process of translating tacit knowledge that some individuals possess into knowledge that can be readily understood by others (explicit) ii. Firm needs to take knowledge, test it, then transfer it other individuals 1. Usually a group process d. Combination: (Explicit explicit) i. explicit knowledge is integrated and recombined ii. existing explicit knowledge is usually recataloged and expanded into new explicit knowledge e. internalization: (Explicit Tacit) i. describes the process of taking explicit knowledge and translating it into tacit knowledge, which can make it easier for individuals to act upon f. spiral of knowledge: i. using all four types of knowledge to create activities that are simultaneously occurring and interacting with each other

ii. occurs when socialization, externalization, combination, and internalization become an ongoing interactive process of learning B. Knowledge storage a. Organizational memory: the collective knowledge available from a variety of explicit and tacit knowledge resources i. Written documents, structured electronic databases, documented firm processes, tacit knowledge, etc. b. Memory is important i. Memory may not supply the exact solution to a new problem, but it facilitates absorptive capacity (the firms ability to evaluate, assimilate, and apply new externally gathered information that is dependent on prior related info) c. Two strategies for storing knowledge i. Codification 1. Computer-centric 2. Firms knowledge is stored in electronic databases a. Electronic databases store three general classifications info i. External knowledge ii. Formal internal knowledge iii. Informal internal knowledge ii. Personalization 1. People-focuses 2. Knowledge is shared through personal contacts (i.e. consultants) C. Knowledge transfer a. The firms ability to retrieve and distribute knowledge b. Transfer conduits i. Informal: water cooler conversations 1. Promote socialization 2. Not effective for firm wide transfer ii. Formal: group training sessions 1. Guarantee widespread transfer 2. May inhibit creativity iii. Personal: internships, shadowing 1. Enable sharing of context-specific knowledge iv. Impersonal: electronic knowledge databases 1. Effective for explicit knowledge 2. Explicit knowledge = easy to transfer c. Signature Processes: unique value-creating practices that resonate with the leaders values and the unique history of the organization D. Knowledge use a. Technological components of knowledge use i. Include groupware, integrated e-mail, discussion groups or newspapers, video conferences, electronic databases, intranets and extranets ii. Effective and implementable knowledge management technical solutions are comparatively easy to evaluate and purchase, and they provide multiple benefits to the firm b. Organizational components of knowledge use

i. glue of an organization ii. Includes organizational culture, incentive systems, compatible organization design, and individual competencies iii. Learning organization: an organization that is able to create, acquire, interpret, transfer, and retain knowledge to purposefully improve the value they create VI. How do organizational systems affect knowledge management? A. Corporate culture and values a. Establishing a supportive learning environment is developing a corporate culture capable of promoting innovation, risk taking, and collaboration b. The culture must encourage individuals to share their knowledge and learning throughout the organization B. Incentive systems a. Intrinsic rewards: internally focused i. Based on personal motivations such as a desire to help others or to build selfesteem b. Extrinsic rewards: externally focused i. Visible to others 1. Financial incentives and public recognition C. Organizational structure a. Must use structure that allows for a quick response time to customer needs and changes in market conditions i. Shorter time to market, higher levels of creativity and innovation, mechanisms for ongoing learning, and the quick adaptation of new technologies b. Organizations that encourage learning and innovation have two important characteristics: i. And increasing reliance on networks of personal relationships ii. And the use of smaller operating units D. Recruitment a. Employees must have the ability to be self-learners and their willingness to share that knowledge and work in teams VII. What are the most important external sources of knowledge? a. KM has an equally important external face: acting as the connection between the firm and its stakeholders, especially customers i. It is also the distinguishing factor among competitors in a knowledge community A. Benchmarking a. Focuses on collecting data and other intelligence that permits comparisons with other firms within or outside an industry to identify how well ones firms is performing its basic function or activities b. The objective of benchmarking is to identify best (or promising) practices and to take actions that improve the firms competitive position B. Contingent employees a. Independent contractors who are brought into the firm as consultants or on-call workers to accomplish a specific task b. Can cut the firms operating costs by reducing benefit costs, recruitment costs, employee turnover, and paid-yet-underutilized hours c. Two key disadvantages

i. Workers may learn about your firm and transfer important competitive knowledge from your firm to competitors ii. The firm may not have the processes in place to capture the knowledge and learning that the contingent workers have to offer, so once their job is finished, continuity is lost C. Strategic alliances a. Cooperative arrangements with other organizations b. Increase a firms knowledge base more quickly and cheaply than outsourcing c. Includes research consortiums, joint ventures, long-term supplier relationships, and licensing arrangements d. Allow firms to extend their spheres of influence beyond the assets they own and to leverage the assets of others to create greater value while minimizing their own capital outlays e. Most important problem: identifying important knowledge and transferring it from the outside environment does not take place automatically D. Distributed expertise a. Not all the smart people work for one company Corporate Governance VIII. Intro A. Definition: the set of mechanisms used to manage the relationship among stakeholders and determine and control the strategic direction and performance of an organization o Concerned with identifying ways to ensure that strategic decisions are made effectively o Establishes order between parties o Reflects and enforces the companys values B. Separation of ownership and managerial control b. Historically, firms were managed by founder-owners and descendents c. Separation of ownership and managerial control allow shareholders to purchase stock, entitling them to income (residual returns) i. Implies risk for this group who mange their investment risk d. Shareholder value reflected in price of stock e. The separation and specialization of ownership (risk bearing) and managerial control (decision making) should produce the highest returns for the firms owners f. Small firms managers are high percentage owners, which implies less separation between ownership and management control (usually family owned) i. 2 critical issues 1. As they grow, they may not have access to all needed skills to mange the growing firm and maximize its returns, so may need outsiders to improve management 2. May need to seek outside capital (and give up some ownership control) D. Why do we need governance a. Shareholders (principal) i. Provide funds ii. Owners with limited liability iii. Limited involvement b. Managers (agents) i. Run the corporation without providing fund

E.

ii. Responsible for working for shareholders (principals) iii. Receive employment and pay c. Board of directors i. Approves major decisions ii. Oversees top management iii. Duty to protect shareholders Agency Relationships a. Relationship between business owners (principals) and decision making specialists to perform a service i. i.e. to manage principals operations and maximize returns on investment ii. clients/consultants; insurer/insured; employee/manager b. problems can surface because the principal and the agent have different interests and goals or because shareholders lack direct control of large publicly traded corporations c. problems also arise when an agent makes decisions that result in the pursuit of goals that conflict with those of the principal d. shareholders want high returns/ high risk e. can lead to managerial opportunism i. managerial opportunism: the seeking of self-interest with guile 1. both an attitude and a set of behaviors 2. principals do not know before hand which agents will or will not act opportunistically f. product diversification: a potential agency problem i. two manager benefits that shareholders dont enjoy 1. increase in firm size (which often increases compensation) 2. firm portfolio diversification can reduce top executive employment risk (i.e. job loss, loss of compensation or reputation) ii. diversification reduces these risks because a firm and its managers are less vulnerable to the reduction in demand associated with a single or limited number of products lines or businesses iii. free cash flows 1. remaining resources after the firm has invested in all projects that have positive net present values within the current business 2. managers want to use to over-diversify the firm (opportunistic) 3. shareholders think they should be distributed as dividends, so they can control how the cash is invested iv. in general 1. shareholders prefer riskier strategies and more focused diversification 2. top executives prefer a level of diversification that maximizes firm size and their compensation and that reduces employment risk g. agency costs and governance mechanisms i. potential conflicts coupled with the fact that principals do not know which managers might act opportunistically, demonstrates why principals establish governance mechanisms ii. the firm incurs costs everytime it uses one or more governance mechanisms

iii. agency costs: the sum of incentive costs, monitoring costs, enforcement costs, and individual financial losses incurred by principals because governance mechanisms cannot guarantee total compliance by the agent iv. if a firm is diversified, governance costs increase because it is more difficult to monitor what is going on inside the firm v. these costs should be associated with improved managerial decision-making and strategic effectiveness h. agency vs stewardship i. stewardship 1. executives motivated to act in best interest of the corporation that their own self-interests 2. over time senior executives tend to view corporation as extension of selves ii. agency 1. objective of owners/ shareholders and agents in conflict 2. difficult for owners to verify agent performance II. Ownership Concentration A. Ownership Concentration: The number of large block shareholders and the total percentage of shares they own B. Large-block shareholders: typically own at least 5 percent of corporations issued shares C. Diffuse ownership: a large number of shareholders with small holdings and few, if any, large-block shareholders g. Produces weak monitoring of managers decisions E. Institutional owners: financial institutions such as stock mutual funds and pensions funds that control large-block shareholder positions a. Pension funds alone control at least one-half of corporate equity F. The growing influence of institutional owners a. Provides size to influence strategy and the incentive to discipline ineffective managers b. Increased shareholder activism supported by SEC rulings in support of shareholder involvement and control of managerial decisions III. Board of Directors A. Group of elected individuals that acts in the owners interests to formally monitor and control the firms top-level executives B. Responsible to: h. Evaluate and advise i. Set strategy and direct the organization ii. Ensure resources are managed well i. Monitor and control i. Hire, fire, punish and reward managers ii. Protect owners from managerial opportunism iii. Supervise executives and set compensation j. Plan and provide i. Use social connections for the firm ii. Provide personal knowledge iii. Determine the firms direction and mission C. Types of directors a. insiders

i. active top-level managers in the corporation who are elected to the board because they are a source of information about the firms day-to-day operations b. related outsiders i. have some relationship with the firm, contractual or otherwise, that may create questions about their independence, but these individuals are not involved with the corporations dayto-day activities c. outsiders i. provide independent counsel to the firm and may hold top-level managerial positions in other companies or may have been elected to the board prior to the beginning of the current CEOs tenure D. Board of directors involvement (low to high) a. phantom: no degree of involvement b. rubber stamp: officers make decisions, board votes on those decisions c. minimal review: formally reviews certain issues that officers bring to attention d. nominal participation: involved to a limited degree in the performance or review of selected key decisions, indicators or programs of management e. active participation: approve questions, makes final decisions on mission, strategy, policies and objectives. Performs fiscal and management audits f. catalyst: takes the leading role in establishing and modifying the mission, objectives, strategy, and policies. Very active strategy committee E. other BOD shit k. Historically, BOD dominated by inside managers l. Managers were suspected of using their power to select and compensate directors m. NYSE implemented an audit committee rule requiring outside directors to head audit committees n. Sarbanes-Oxley Act passed leading to BOD changes o. CG becoming more intense through BOD mechanism p. BOD scandals led to trend of separating roles of CEO and chair person G. Outside directors a. Improve weak managerial monitoring and control that corresponds to inside directors b. Tend to emphasize financial controls, to the detriment of risk related decisions by managers, as they dont have access to daily operations and a high level of information about managers and strategy c. Large number of outsiders can create problems i. Limited contact with the firms day-to-day operations and incomplete information about managers 1. Results in ineffective assessments of managerial decisions and initiatives 2. Emphasizes financial, as opposed to strategic, controls to gather performance information to evaluate performance of managers and business units, which could reduce R&D investments, increase diversification, and pursue higher compensation to offset their employment risk H. Interlocking Directorate a. CEOs often nominate executives or other board members to create an interlocking directorate i. May provide information ii. May be used for collusion

b. Direct interlocking: 2 boards of directors share at least 1 director in common c. Indirect interlocking: 2 boards are linked through sitting on another board I. Enhancing the effectiveness of the BOD recent changes a. Increased diversity in board members backgrounds b. Establishment and consistent use of formal processes to evaluate the boards performance c. Creation of a lead director that has strong agenda-setting and oversight powers d. Modified compensation of directors e. Requires that directors own significant stakes in the company in order to keep focused on shareholder interests IV. Executive compensation A. Executive compensation: governance mechanism that seeks to align the interests of top managers and owners through salaries, bonuses, and long-term incentive compensation, such as stock awards and stock options a. Thought to be excessive and out of line with performance b. Alignment of pay and performance: complicated board responsibility c. The effectiveness of pay plans as a governance mechanism is suspect B. Effectiveness of executive compensation a. Complicated, especially long-term incentive compensation i. Quality of complex and non-routine strategic decisions that top-level managers make is difficult to evaluate ii. Decisions affect financial outcomes over an extended period, making it difficult to assess the effect of current decisions on corp performance iii. Many external factors affect a firms performance in addition to top-level management decisions and behavior iv. Performance-based compensation used to motivate decisions that best serve shareholder interests are imperfect in their ability to monitor and control managers v. Incentive-based compensation plans intended to increase firm value, in line with shareholder expectations, subject to managerial manipulation to maximize managerial interests vi. Many plans seemingly designed to maximize manager wealth rather than guarantee a high stock price that aligns the interests of managers and shareholders b. Stock options are highly popular as compensation i. Re-pricing: strike price value of options is commonly lowered from its original position ii. Back-dating: options grant is commonly dated earlier than actually drawn up to ensure an attractive exercise price V. Market for Corporate Control A. Market for corporate control: external governance mechanism consisting of a set of potential owners seeking to acquire undervalued firms and earn above-average returns on their investments a. Becomes active when a firms internal controls fail B. Need for external mechanisms exists to: a. Address weak internal corporate governance b. Correct suboptimal performance relative to competitors c. Discipline ineffective or opportunistic managers C. External mechanisms are less precise than internal governance mechanisms D. Managerial defense tactics

a. b.

Hostile takeovers are the major activity i. Not always due to poor performance Defense strategies i. Poison pill: preferred stock in the merged firm offered to shareholders at a highly attractive rate of exchange 1. Preventive measure 2. High popularity 3. High effectiveness 4. Positive stockholder wealth effects ii. Corporate charter amendment iii. Golden parachute iv. Litigation v. Greenmail vi. Standstill agreement vii. Capital structure change

Article: Extending the easy Business Model: What should easyGroup do next? Ch 9: Strategic Alliances What is a Strategic alliance? A. There are only three ways for a company to grow a. Internal development (growth from within) i. Slowest route b. Strategic alliances / joint ventures c. Merger / acquisition (next chapter) i. Quickest route / most risky B. Using alliances reduces costs a. Create economic value by: i. Accessing complementary resources and capabilities ii. Leveraging existing resources and capabilities b. An alliance is an organizational form of exchange that should: i. Produce a gain from trade due to some comparative or absolute advantage 1. Implication: choose partners that are better at something than you are (complementary resource) C. Strategic alliance: exists whenever two or more independent organizations cooperate in the development, manufacture or sale of products of services a. Nonequity Alliance: cooperating firms agree to work together to develop, manufacture, or sell products or services, but they do not take equity positions in each other or form an independent organizational unit to manage their cooperative efforts i. These cooperative relations are managed through the use of various contracts ii. EXs: 1. Licensing agreements: where one firm allows other to use its brand name to sell products 2. Supply agreements: where one firm agrees to supply others 3. Distribution agreements: where one firm agrees to distribute the product of others

Equity Alliance: cooperating firms supplement contracts with equity holdings inn alliance partners i. Very common in the biotechnology industry ii. One company wont screw the other over because both hold ownership c. Joint venture: cooperating firms create a legally independent firm in which they invest and from which they share any profits that are created i. AT&T and BellSouth created Cingular; AT&T owns 60%, BellSouth owns 40% rd ii. A 3 company is formed with a parent company and joint owner 1. Less liable for parent company than creating on their own How do strategic alliances create value? A. Like all strategies discussed, strategic alliances create value by exploiting opportunities and neutralizing threats facing the firm B. Strategic alliance opportunities a. Opportunities to improve performance of its current operations i. Exploiting economies of scale 1. Economies of scale: when the per-unit cost of production falls as the volume of production increases 2. A partner brings increased market share and/or manufacturing capacity 3. When a firm cannot realize the cost savings from economies of scale all by itself, it may join in a strategic alliance with other firms 4. If the volume of production required to realized these economies of scale is very large, a single firm might have to dominate an entire industry to obtain these advantages a. This is very difficult b. Govt might impose anti-monopoly regulations ii. Learning from competitors 1. A partner brings technology and/or market knowledge 2. Different firms in an industry have different resources and capabilities 3. Firms that are at a competitive disadvantage may want to form alliances with firms that have an advantage in order to learn about their R&Cs 4. EX: GM (plant operations) and Toyota (lean manufacturing) a. When both parties to an alliance are seeking to learn something from that alliance, an interesting dynamic called learning race can evolve iii. Managing risk and sharing costs 1. A partner bears a portion of the risk and/or cost of the alliance 2. EX: HBO producing TV shows with independent producers a. Share risk and costs but also share profits b. Opportunities to Create a competitive environment favorable to superior performance i. Facilitating the development of technology standards 1. Partners may agree on a standard and avoid a market battle for the standard a. EX: Blue Ray (SA btwn sony, sharp, apple and tdk) vs HD-DVD 2. Standards can also be set by letting consumers decide which they prefer a. EX: betamax vs. VHS 3. Important in network industries a. Characterized by increasing returns to scale

b.

i. The value on each product increases as the number of these products increases ii. Facilitating tacit collusion 1. Partners may communicate with an alliance in subtle, legal ways whereas the same communication between competitors outside an alliance would be illegal 2. Collusion: exists when two or more firms in an industry coordinate their strategic choices to reduce competition in the industry 3. Explicit collusion: exists when firms directly communicate with each other to coordinate their levels of production, their price, and so forth 4. Tacit collusion: exists when firms coordinate their production and pricing decisions, not by directly communicating with each other, but by exchanging signals with other firms about their intent to cooperate a. Signal: public announcement c. Opportunities to facilitate entry and exit i. Most valuable when markets are uncertain ii. Low-cost entry into new industries and new industry segments 1. A partner provides instant access and legitimacy 2. Partner with an experienced firm in the industry attempting to enter: this will reduce the costs and difficulty of breaking into a new industry iii. Low-cost exit from industries and industry segments 1. A partner is an informed buyer 2. When a firm exits an industry, they must sell all their assets a. If they previously had a strategic alliances, their partner will be more willing to buy these assets for an appropriate price iv. Managing uncertainty 1. Alliances may serve as real options 2. EX: Disneys partner with Pixar b/c uncertainty with computer technology v. Low-cost entry into geographic new markets 1. Partners provide local market knowledge, access, and legitimacy with governments and customer Alliance Threats: Incentives to cheat on Strategic Alliance A. 1/3 of all strategic alliances do not meet the expectations of at least one alliance partner B. Incentives to cheat an alliance when it is an exchange context in which: a. Partner inputs may be difficult to monitor b. Actual value creation (performance) may be difficult to monitor c. Value appropriation (allocating value) may be difficult to monitor or subject to power dynamics C. Adverse Selection: exists when an alliance partner promises to bring to an alliance certain resources that either does not control or cannot acquire a. Potential partners can misrepresent the skill, abilities, and other resources that they will bring to an alliance b. The less tangible the R&C that are to be brought to a strategic alliance, the more costly it will be to estimate their value before an alliance is created, and the more likely it is that adverse selection will occur c. Firms considering alliances that bring intangible resources such as contacts with key political figures or knowledge of local conditions will need to guard against cheating

D. Moral Hazard: partners in an alliance may possess high-quality R&Cs of significant value but fail to make those R&Cs available to alliance partners a. EX: partner says theyre sending their most experienced and best trained engineers, but then doesnt i. These less talented engineers then learn a great deal from the highly qualified engineers provided by other alliance partners E. Holdup: when on firm makes more transaction specific investments in a strategic alliance than the partner firm makes a. Once a strategic alliance has been created, partner firms may make investments that have value only in the context of that alliance and in no other economic exchanges b. Transaction specific investment: when an investments value in its first-best use (in this case, within the alliance) is much greater than its value in its second-best use (outside the alliance) c. Holdups occur when a firm that has not made significant transaction specific investments demands returns from an alliance that are higher than originally agreed Strategic Alliances and Sustained Competitive advantage A. Rarity of Strategic Alliances a. Depends on the number of competing firms that have already implemented strategic alliances AND whether the benefits that firms obtain from their alliances are common b. One reason why the benefits that accrue from a particular strategic alliance may be rare is that relatively few firms may have the complementary resources and abilities needed i. This is likely when an alliance is formed to enter into a new market, especially a new foreign market B. Imitability of Strategic Alliances a. Direct duplication i. Successful strategic alliances are often based on socially complex relationships among alliance partners 1. This is hard to duplicate, thus if you have it, you have a competitive adv. b. Substitution i. Going it alone 1. When firms attempt to develop all the resources and capabilities they need them selves 2. Substitute when going it alone creates the same or more value than using alliances a. Called vertical integration 3. Not a substitute when it does not create more value 4. Alliance will be preferred over going it alone when: a. The level of transaction-specific investment required to complete an exchange is moderate b. An exchange partner possessed valuable, rare, and costly-to-imitate R&Cs c. There is great uncertainty about the future value of an exchange ii. Acquisitions 1. Rather than developing a strategic alliance, a firm seeking to exploit opportunities may simply acquire another firm that already has the relevant R&Cs

C.

4 characteristics that limit the extent to where acquisitions can be a substitute for strategic alliances a. There are legal constraints b. Acquisitions limit a firms flexibility (in exiting and entering) under conditions of high uncertainty c. There is substantial unwanted organization baggage (parts of the firm that do not create value) in an acquired firm d. The value of a firms R&Cs depends on its independence Organizing to implement strategic alliances Tools and mechanisms to help realize the value of alliances and minimize the threat of cheating a. Explicit contracts and legal sanctions (formal/codified) i. A way to avoid cheating is to anticipate the ways in which cheating could occur and to write explicit contracts that define legal liability if cheating does occurs ii. Such strategic alliances are called nonequity alliances iii. However, parties cannot always foresee all forms of cheating iv. Creates mutual understanding v. Imposes costs for cheating b. Equity Investments (formal/codified) i. Aligns the interest of partners through ownership in each other ii. Indirect effect iii. The effectiveness of contracts can be enhanced by having partners in an alliance make equity investments in each other iv. These kinds of strategic alliances are called equity alliances v. Cross-equity investments 1. Where a firms largest equity holders often include several of key suppliers including main banks 2. Can reduce supply costs as well as risk of cheating c. Firm reputations (informal) i. Information about an alliance partner that has cheated is likely to become widely known and effect their reputation ii. Limitations to cheating ruining a reputation and thus a firms future business opportunities 1. Subtle cheating may not become public 2. Cheating my not be subtle or ambiguous, but the firm could be apart of a network in which the information is neglected to be made public 3. A non subtle and unambiguous cheating firm which is made publically known may incur large losses due to the lost alliance a. Thus, their ruined rep is the least of their problems d. Joint Ventures (formal/codified) i. Aligns interests of partners through ownership of independent firm ii. Direct effect iii. Investing in a joint venture reduces the chance of cheating to occur iv. All partners are heavily invested and rely on profits, so they dont cheat v. However, sometimes the gain form cheating is larger than the loss that would occur from losing the joint venture, so they cheat anyways e. Trust (informal)

2.

i. May allow partners to exploit opportunities that would be infeasible with other mechanisms ii. Trust in combination with contracts can help reduce the threat of cheating iii. Best way to create a sustained competitive advantage in strategic alliance Extra Notes A. Corning and Cisco are the most well known for their strategic alliance success B. Vertical complementary strategic alliance a. Formed between firms that agree to use their skills and capabilities in different stages of the value chain to create value for both firms C. Horizontal complementary strategic alliance a. Formed when partners who agree to combine their resources and skills to create value in the same stage of the value chain b. Alliance with direct competitors c. Most risky d. Big risks for opportunism D. Alliance may be attractive during expansions because: a. Local market knowledge is usually critical b. Governments may require a local partner c. International expansion may be: i. Fraught with uncertainty and high risk ii. Expensive d. Alliance investment may be more easily reversed than internal development or acquisition Ch 10: Mergers and Acquisitions Corporate level strategy should create value: A. Such that the value of the corporate whole increase B. Such that businesses forming the corporate whole are worth more than they would be under independent ownership C. That equity holders cannot create through portfolio investing What are Mergers and Acquisitions? A. Acquisition: when a firm purchases a second firm a. Can be a controlling share, a majority or all of the target firms stock b. Can be friendly or hostile c. Usually done through a tender offer d. A firm can use its cash, debt or equity to purchase a second firm (or a mix of all) e. Or they can purchase a controlling share i. Purchasing enough assets so that the acquiring firm is able to make all management and strategic decisions in the target firm f. Acquisitions and mergers are often used interchangeably but they are not synonyms g. Friendly acquisitions: occur when the management of the target firm wants the firm to be acquired h. Unfriendly acquisitions: occur when the management of the target firm does not want the firm to be acquired (also known as hostile takeovers) i. Some acquisitions are accomplished through direct negotiations between an acquiring firms managers and the managers of a target firm

i. This is common in privately held firms (no IPO) and closely held firms (not sold many shares on the public market) j. Some acquisitions happen when a firm publicly announces they want to purchase a target firm for more than their shares are worth i. The difference between the current market price and the offered price is called acquisition premium ii. This approach is called a tender offer iii. Can be made with or without the target firms management B. Merger: when the assets of two similar sized firms are combined; two firms are combined on a relatively co-equal basis a. Can occur in many of the same ways as acquisitions, but will not usually be unfriendly b. Usually, one firm invests in share of the other and vice versa c. Parent stocks are usually retired and new stock is issued d. Name may be one of the parents or a combination e. One of the parents usually emerges are the dominate management The value of Mergers and Acquisitions A. Mergers and acquisitions between unrelated firms a. A firms shares are worth a certain amount b. Any price for a target that is less than this value will be economic profit for bidding firm c. Price = to value will be zero economic profit for bidding firm d. Price > than value is economic losses for bidding firm e. There would be no expectation of value creation due to the lack of synergies between businesses f. There might be value creation due to efficiencies from an internal capital market g. There might be a value creation due to the exploitations of a conglomerate discount i. A corporate raider who buys and restructures firms B. Mergers and acquisitions between related firms a. The acq. Of related firms will generate zero economic profits for both the bidding and target firms b. Value creation would be expected due to synergies between divisions i. Economies of scale ii. Economies of scope 1. Transferring competencies 2. Sharing infrastructure, etc c. Types of strategic relatedness i. The FTC categories 1. Because mergers and acq can have the effected of increasing or decreasing the level of concentration in an industry, the federal trade commission is charged with the responsibility of evaluating the competitive implications of proposed mergers and acq 2. Will disallow and potential for a monopoly 3. Vertical merger: when a firm vertically integrates either forward or backward through its acquisition efforts a. Purchasing suppliers (forward) or customers (backward) b. Increases a firms market power by controlling additional parts of the value chain 4. Horizontal merger: when a firm acquires a former competitor

Acquisition of a company in the same industry in which the acquiring firm competes b. Increases a firms market power by exploiting i. Cost based synergies ii. Revenue based synergies c. Acquisitions with similar characteristics result in higher performance than those with dissimilar characteristics 5. Product extension merger: firms acquire complementary products 6. Market extension merger: to gain access to new geographic markets 7. Complementary acquisition: acquisition of a company in a highly related industry or products a. Because of the difficulty in implementing synergy, complementary acquisitions are often difficult to implement 8. Conglomerate merger: residual category; everything else that cannot be defined a. Not common b. An unrelated M&A activity ii. Other types of strategic relatedness 1. Technical economies: related in marketing, production, etc 2. Pecuniary economies: related in market power 3. Diversification economies: related in portfolio management and risk reduction iii. Economic profits in related acquisitions 1. If the bidding and target firms are strategically related, then the economic value of these two firms combined is greater than separate C. Entry Barriers a. Factors associated with the market or with the firms operating in it that increase the expense difficulty faced by new ventures trying to enter that market i. Economies of scale ii. Differentiated products D. Cross border acquisition a. Acquisitions made between companies with head quarters in different countries i. Are often made to overcome entry barriers ii. Can be difficult to negotiate and operate because of the differences in foreign cultures E. Cost of new product development and increased speed to market a. Internal development of new products is often perceived as high-risk activity i. Acq allow a firm to gain access to new and current products that are new to the firm ii. Returns are more predictable because of the acquired firms experience with the products b. An acq outcomes can be estimated more easily and accurately than the outcomes of an internal product development process i. Managers may view acquisitions as lowering risk associated with internal ventures and R&D investments ii. Acq may discourage or suppress innovation F. Increases diversification a. Using acq to diversify a frim is the quickest and easiest way to change its portfolio of businesses

a.

Both related diversification and unrelated diversification strategies can be implemented through acquisitions c. The more related the acquired firm is to the acquiring firm, the greater is the probability that the acquisition will be successful G. Reshaping the firms competitive scope a. An acquisition can: i. Reduce the negative effect of an intense rivalry on a firms financial performance ii. Reduce a firms dependence on one or more products or markets 1. Reducing a companys dependence on specific markets alters the firms competitive scope H. Learning and developing new capabilities a. An acquiring firm can gain capabilities that the firm does not currently have i. Special technology capability ii. A broader knowledge base iii. Reduced inertia b. Firms should acquire other firms with different but related and complementary capabilities in order to bild their own knowledge base What does research say about returns to mergers and acquisitions? A. Target firm market value increases on average about 25% while bidding firms remain unchanged B. So why are there so many mergers and acquisitions if it only creates a competitive parity? a. To ensure survival i. In order to not be at a competitive disadvantage, mergers and acq happen to create competitive parity and normal economic profits ii. Avoid scale disadvantages b. Free cash flow i. Free cash flow: the amount of cash a firm has to invest after all positive net present value investments have been funded ii. Firms can invest their free cash flow to create mergers and acq c. Agency problems i. Can benefit managers even if it does not benefit equity holders 1. Helps diversify their human capital 2. Quickly increases firm size, measured in scale or assets a. If management compensation is closely linked to firm size, this is benefit for them d. Managerial hubris i. Managerial hubris: the unrealistic belief held by managers in bidding firms that they can manage the assets of a target firm more efficiently than the target firms current management e. The potential for economic profits i. In some situations bidding firms may be able to gain competitive advantages form mergers and acq activities C. Major factors in making an M&A decision a. Managers should weight each factor depending on its importance to their industry b. First managers should look at their resources i. Types of synergies ii. Nature of resources

b.

iii. Extent of redundancy c. Then the firm should look at uncertainty in the market d. Lastly, the firm should consider competition Merger and Acquisitions and Sustained Competitive advantage A. Can an M&A strategy generate sustained competitive advantage a. Yes, if managers abilities meet VIRO criteria i. Managers may be good at recognizing and exploiting potentially value-creating economies with other firms ii. Managers may be good at doing deals iii. Managers may be good at both B. The market for competitive control: the market that is created when multiple firms actively seek to acquire one or several firms a. Only when the market for corporate control is imperfectly competitive might it be possible for bidding firms to earn profits C. Valuable, rare and private economies of scope a. An imperfectly competitive market for corporate control can exist when a target is worth more to one bidder than the others, but no one is aware of this additional value b. A firm has to possess valuable and rare links with bidding firms to gain economic profits and competitive advantages from its acq strategies, but info about these special economies of scope must not be know by other firms i. If its known by other firms, those firms will try to duplicate the value themselves D. Valuable, rare and costly-to-imitate economies of scope a. If other bidders cannot imitate one bidders valuable and rare economies with targets, then competition in this market will be imperfect and equity holders will earn profits b. Unexpected valuable economies of scope between bidding and target firms i. The difference between the unexpected value of the acquisition and the price the bidder paid is the profit for equity holders c. Implications for bidding firm managers i. The rules for bidding managers 1. Search for valuable and rare economies of scope a. Over rules inter firm linkages 2. Keep information away from other bidders a. Avoid multiple bidders for one target b. Some times illegal to hold information i. When seeking to acquire publicly traded firms, potential bidders must meet disclosure requirements 3. Keep information away from targets 4. Avoid winning bidding wars 5. Close the deal quickly 6. Operate in thinly traded acquisition markets a. Thinly traded markets: a market where there are only a small number of buyers and sellers, where info about opportunities in this market are not widely known, and where interests besides purely maximizing the value of a firm can be important b. In the context of mergers and acquisitions: markets where only a few (or one) firms are implementing acquisition strategies

c. Highly fragmented industries Implications for target firm managers i. Rules for target firm managers 1. Seek information from bidders 2. Invite other bidders to join the bidding competition 3. Delay but do not stop the acquisition Organizing to implement a merger or acquisition A. Post merger integration and implementing a diversification strategy a. Mergers and acquisitions designed to implement diversification i. M-form structure ii. Management controls and compensation policies that are similar to those used in a diversification strategy b. Mergers and acquisitions designed for vertical integration i. U-form structure ii. Target firms can remain somewhat autonomous or may be completely integrated B. Special challenges in post merger integration a. Operational, functional, strategic, and cultural differences between bidding and target firms involved in a merger or acquisition are likely to be much greater than these same differences between parts of a diversified or vertically integrated firm i. Reason: separate histories, separate management philosophies, and separate strategies b. Cultural differences are the largest challenge i. High levels of integration require greater cultural blending ii. Cultural blending maybe a matter of: 1. Combining elements of both cultures 2. Essentially replacing one culture with the other iii. Integration may be very costly, often unanticipated iv. The ability to integrate efficiently may be a source of competitive advantage c. Challenges are though of as an additional cost C. Government policy a. Governments may constrain ownership by foreign firms b. Governments may restrict repatriation of profits c. Government labor policy may limit a firms ability to apply management practices to target firms D. Problems in achieving acquisition success a. Problems with integration difficulties i. Melding two disparate corporate cultures ii. Linking different financial and control systems iii. Building effective working relationships (particularly when management styles differ) iv. Resolving problems regarding the status of the newly acquired firms executives v. Loss of key personnel weakens the acquired firms capabilities and reduces its value b. Problems with inadequate evaluation of the target i. Due diligence 1. The process of evaluating a target firm for acquisition a. Ineffective due diligence may result in paying an excessive premium for the target company 2. Managers may be over confident in their abilities 3. Bidding wars often override valuation d.

4. Must entice shareholders to sell stock which often results in paying a premium ii. Evaluation requires examining: 1. Financing of the intended transaction 2. Differences in culture between firms 3. Tax consequences of the transaction 4. Actions necessary to meld the two workforces Advantages and disadvantages of M&As A. Advantages a. Reducing competition b. Getting access to proprietary products or services c. Gaining access to new products of services d. Gaining access to new products and markets e. Access to technical expertise f. Access to an established brand name g. Economies of scale h. Diversification of business risk B. Disadvantages a. Incompatibility of top management b. Clash of corporate cultures c. Operational problems d. Increased business complexity e. Loss of organizational flexibility f. Antitrust implications McKinsey 7S Model: Great Application fro M&As A. Check list: synergies sough (strategy, systems, structure) a. Reduced fixed costs b. Increased market share c. Cross-sales d. Greater economies of scale e. Lower taxes f. More efficient resource distribution B. Psychological traits driving M&As (blinds spots?) skills, shared values, staff, style a. Empire-building b. Hubris c. Fear d. Mimicry C. Five types of strategic fit (strategy, systems, structure) a. Overcapacity M&A b. Geographic roll-up M&A c. Product or market extension M&A d. M&A as R&D e. Industry convergence M&A D. Critical issues post-implementation (shared values, skills, staff, style) a. Incompatible corporate cultures b. Business as usual c. High executive turn over

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F.

d. Neglect business at hand Steps before the deal (strategy, systems, structure) a. Begin by formulating a clear strategy b. Pre-access the deal c. Do your due diligence d. Devise a workable plan e. Communicate Steps after the deal (all 7S) a. Establish leadership b. Manage culture and respect employees of merged/acquired company c. Explore new growth opportunities d. Exploit early wins e. Focus on the customer